How the Market Responds to US CPI may set the Near-Term Course

<div><a href="https://blogger.googleusercontent.com/img/a/AVvXsEhxLtaTpYLARFF7HgPlt5n6vOxyrr54CYcfi7Kpf5saPm8frC-PzBsW7L7aLyt8FwNGz7T5BMWgz-rUrFLGDfKCJ1L7fW5Cey7V17mSeOtIHPHvO3jvJDaXigXVWMGWsnytfxjMRmsBceRHZrrtq0zTOouuewEe8QeJAkVKAGYZEtZTQSdL_JPPV5lHjg=s314"><img alt="" border="0" data-original-height="238" data-original-width="314" src="https://blogger.googleusercontent.com/img/a/AVvXsEhxLtaTpYLARFF7HgPlt5n6vOxyrr54CYcfi7Kpf5saPm8frC-PzBsW7L7aLyt8FwNGz7T5BMWgz-rUrFLGDfKCJ1L7fW5Cey7V17mSeOtIHPHvO3jvJDaXigXVWMGWsnytfxjMRmsBceRHZrrtq0zTOouuewEe8QeJAkVKAGYZEtZTQSdL_JPPV5lHjg=s400" width="400" /></a></div><p><b><span>Overview:</span></b><span>&nbsp; US stocks built on the recovery started on Monday and Powell's suggestion of letting the balance sheet shrink later this year eased some speculation of a fourth hike this year, which seemed to allow the Treasury market to stabilize.&nbsp; What amounts to a greater appetite for risk is carrying over into Asia Pacific activity today. Many of the large bourses advanced more than 1%, with the Hang Seng up almost 2.8% and the Nikkei up&nbsp; nearly as much.&nbsp; &nbsp;Bond yields pulled back mostly 2-4 bp in the region, but higher unemployment (3.8% vs. 3.1%) saw the 10-year South Korean yield fall by six basis points.&nbsp; Europe's Stoxx 600 opened higher but has stalled, while US futures recover from initial weakness to move higher.&nbsp; &nbsp;European yields are around 2-2.5 bp lower,&nbsp; Portugal is under-performing as new supply seems to be weighing on prices.&nbsp; The US 10-year Treasury is hovering near 1.74%.&nbsp; The dollar is little changed against most of the major currencies.&nbsp; Norway reported stronger mainland GDP (Nov +0.7% after flat in October) underscoring the likelihood that the Norges Bank raises rates at next week's meeting, and the krone is up nearly 0.6%.&nbsp; The Canadian dollar, which appeared to break higher yesterday, is extending the gains today.&nbsp; Similarly, most emerging market currencies are +/- 0.15%, but the South Korean won (~+0.35%) and the South African rand (~+0.3%) are the main exceptions.&nbsp; Turning to commodities, gold is paring yesterday's 1.1% advance, giving back nearly a quarter.&nbsp; Energy prices are firm.&nbsp; February WTI is extending yesterday's gains.&nbsp; It is approaching last year's high set in late October near $82.15.&nbsp; Natural gas prices are higher too. US prices are up for the fourth session amid a cold snap.&nbsp; Today's gains bring the year-to-date gain to about 18%, while Europe's benchmark is up nearly a quarter so far this year.&nbsp; Floods in Brazilian iron ore mines have underpinned the industrial metal recently, which is at a new three-month high today.&nbsp; Copper prices are up about 1.7% for the second consecutive session.&nbsp; They fell by 1.2% last week.&nbsp; &nbsp;</span></p> <p><b><span>Asia Pacific</span></b><span><o:p></o:p></span></p> <p><b><span>China's December CPI and PPI were softer than expected, while aggregate lending figures were in line with expectations.&nbsp;&nbsp;</span></b><span>Helped by softer food and non-food prices, as well as services, due partly to the lockdowns, saw CPI ease to 1.5% from 1.7%.&nbsp; Excluding food and energy, the core measure was unchanged at 1.2%.&nbsp; The government has taken steps to ease commodity supplies.&nbsp; The PPI slowed to 10.3% from 12.9%.&nbsp; The median forecast in Bloomberg's survey was for 11.3%.&nbsp; Aggregate financing slowed to CNY2.37 trillion from CNY2.61 trillion in November.&nbsp; Economists projected CNY2.4 trillion.&nbsp; The slowing was nearly evenly divided between banks and the shadow banking sector.&nbsp; The PBOC is still expected to ease policy ahead of the Lunar New Year holiday that begins January 31. While some look for another reserve reduction, a small cut in the 1-year medium-term lending facility next week is also a possibility.&nbsp;<o:p></o:p></span></p> <p><b><span>Ahead of next week's meeting, the BOJ raised its economic assessment of all the country's regions for the first time in more than eight years.&nbsp;</span></b><span>&nbsp;The easing of the pandemic was the main driver.&nbsp; The outlook for consumer spending was also lifted, though wage growth remains miserly.&nbsp; &nbsp;Separately, Japan reported that November's current account narrowed to almost JPY900 bln from JPY1.18 trillion.&nbsp; The November balance has been consistently smaller than October, but it held better than expected.&nbsp; The median forecast (Bloomberg survey) was for a surplus slightly less than JPY600 bln.&nbsp; Even though the trade deficit was less than expected at around JPY431 bln, its swing into deficit from the nearly JPY167 surplus in October accounted for the deterioration.&nbsp; The data also showed that Japanese investors were sellers of US, Australian German, and French sovereign bonds, but buyers of Canadian, Italian and UK paper.&nbsp;&nbsp;<o:p></o:p></span></p> <p><b><span>The dollar remains in the range set on Monday against the Japanese yen (~JPY115.05-JPY115.85).&nbsp;&nbsp;</span></b><span>In fact, it has been confined to less than a quarter of a yen range below JPY115.45.&nbsp; There is an option at JPY115.50 for almost $640 mln that expires today.&nbsp;<b>The Australian dollar closed above $0.7200 yesterday and has edged a little higher today (to almost $0.7225), but the market appears to be turning auction ahead of the US CPI report.</b>&nbsp; Support is seen near $0.7185.&nbsp;&nbsp;<b>The greenback gapped lower against the Chinese yuan.&nbsp;&nbsp;</b>Yesterday's low was about CNY6.3705, while today, it has held below CNY6.3690.&nbsp; Indeed, it recorded the low since the end of last year today (~CNY6.3630) despite softer inflation readings.&nbsp; The PBOC set the dollar's reference rate at CNY6.3658.&nbsp; The median expectation (Bloomberg survey) was for CNY6.3671.&nbsp;&nbsp;<o:p></o:p></span></p> <p><b><span>Europe</span></b><span><o:p></o:p></span></p> <p><b><span>The unexpected weakness in German and French November industrial output reports was not offset by the strength of Spain's production&nbsp;but with seasonal adjustments, the eurozone reported a 2.3% gain.&nbsp;&nbsp;</span></b><span>However, the weakness that was expected was in October.&nbsp; The initial 1.1% gain was revised to a 1.3% decline.&nbsp; It leaves the year-over-year, workday adjusted, pace at -1.5%.&nbsp; The median forecast (Bloomberg) was for a 1.2% gain.&nbsp; October's 3.3% pace was slashed to 0.2%.&nbsp; On Friday, Germany will be the first G7 country to estimate Q4 GDP.&nbsp; Europe's biggest economy is expected to have slowed sharply. After growing 1.7% quarter-over-quarter in Q3, economists expect it to have slowed to 0.5%.&nbsp; We suspect the risk is on the downside.&nbsp;&nbsp;<o:p></o:p></span></p> <p><b><span>The market still seems arguably too relaxed about the deteriorating political climate in Italy.</span></b><span>&nbsp; More reports suggest Draghi may indeed become the next president.&nbsp; That would mean stepping down as premier.&nbsp; The League has been reluctant to support Berlusconi for president.&nbsp; Berlusconi threatened to pull out of the coalition if he does not become president.&nbsp; That would bring the general election forward from next year.&nbsp; The center-left PD appears to be neck-to-neck with both the League and the Brothers of Italy (from the right and more hostile toward the EU).&nbsp; And if Draghi were to stay as Prime Minister, his influence may be waning, and in any event, without a political party, he would likely be replaced after next year's planned election.&nbsp;&nbsp;<o:p></o:p></span></p> <p><b><span>The euro tested this year's high, slightly below $1.1380 in late Asia before drifting lower (~$1.1355).&nbsp;</span></b><span>&nbsp;Support is seen in the $1.1320 area.&nbsp; The single currency has not been above $1.14 since mid-November, and there is a 930 mln euro option that expires there today.&nbsp; With a few exceptions, the euro has been trapped in the range set on November 30 (~$1.1235-$1.1385).&nbsp; With a more hawkish Fed, Russia still poised to take another piece of Ukraine, Italian political stability potentially unraveling, and increased tension within the EU (EC fining Poland 1 mln euros a day for violating the European Court of Justice rulings on judicial independence), the euro still seems vulnerable.&nbsp;<b>&nbsp;In the UK, Prime Minister Johnson appears to be fighting for his political future, but sterling extended the rally that began last month near $1.3165 to reach almost $1.3650 today.&nbsp;</b>&nbsp;A trend line from last July's high (~$1.3985) and the October highs (~$1.3830-$1.3835) comes in now around $1.3690. Sterling is struggling to maintain the upside momentum now.&nbsp; Almost GBP800 mln in options struck at $1.3595-$1.3600 expire today.&nbsp;&nbsp;<o:p></o:p></span></p> <p><b><span>America</span></b><span><o:p></o:p></span></p> <p><b><span>Powell used his confirmation hearings to assure Senators (and his wider audience) that the Fed will defend price stability and prevent inflation from becoming entrenched.&nbsp;&nbsp;</span></b><span>&nbsp;He continued to suggest price pressures may last through mid-year.&nbsp; This is important, even though officials have dropped the "transition" characteristic of inflation, they have pushed out a couple of quarters compared to around a year ago when it anticipated price pressures to ease.&nbsp; Powell has not provided much specifics about the balance sheet, besides suggesting it would take 2-4 meetings to sort out.&nbsp; He did confirm that it will likely begin shrinking later this year; "sooner and faster" than last time.&nbsp; The Fed Chair also introduced the possibility of accelerating tapering.&nbsp; The Fed has indicated that the Fed funds rate will remain its chief tool but allowing the balance sheet to shrink supplants a fourth hike this year.&nbsp;&nbsp;<o:p></o:p></span></p> <p><b><span>Many market observers see two main upside risks to US inflation: wages and shelter costs.</span></b><span>&nbsp; Given the changes in the participation rate, some suspect that the neutral level of unemployment may be a bit higher than the Fed projects.&nbsp; However, the same type of logic could suggest that the real neutral short-term interest rate (r*) is lower than the Fed identifies, meaning financial conditions may be tightening more than assumed.&nbsp; The US December CPI is front and center today.&nbsp; It is expected to edge to about 7% from 6.8% in November.&nbsp; Many economists, but of course not all, see it peaking shortly.&nbsp; How the market responds today may offer important insight into positioning and psychology.&nbsp; Has the news already been largely discounted?&nbsp; The Fed's Beige Book, later today, will offer a glimpse into how the economy is holding up in light of the Delta surge and now the Omicron deluge.&nbsp; The Fed's Kashkari speaks today.&nbsp; What a dove means is always contextual, and seemingly favoring two hikes this year, he is a dove.&nbsp;&nbsp;<o:p></o:p></span></p> <p><b><span>The US dollar punched through the CAD1.26 level we identified as the neckline of a potential head and shoulders pattern that project toward CAD1.2250.</span></b><span>&nbsp; Follow-through has seen the greenback trend lower in the European morning to below the CAD1.2544 area, which corresponds to the (61.8%) retracement of the rally off the late October low.&nbsp; The next immediate target is around CAD1.25, where the 200-day moving average is found.&nbsp; Note that the lower Bollinger Band (~CAD1.2550) has been taken out.&nbsp;&nbsp;<b>Meanwhile, the US dollar is bouncing along its trough against the Mexican peso.&nbsp;</b>&nbsp;Yesterday's November industrial production report disappointed, showing a 0.1% decline rather than the 0.6% advance that economists (Bloomberg survey) expected.&nbsp; The dollar did slip to a two-week low yesterday (~MXN20.3415).&nbsp; Yesterday's high was about MXN20.4550.&nbsp; If this is not taken out, the greenback would record its fourth session of lower highs.&nbsp;<o:p></o:p></span></p><p><span><br /></span></p><p><span><br /></span></p><p><span>Disclaimer</span></p><div>
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