Sive Morten
Special Consultant to the FPA
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Fundamentals
This week the combination of different data was thrilling. The week has started with encouraging J. Powell's speech that calms down investors a bit, but later there are more negative information has appeared. Spreading of omicron variant, rather high inflation data, mixed banks financial earnings results in the IVQ leads to drying of optimism a bit. In fact, this week we've got an important combination of data, the one that we've talked about in the last report - inflation stands high, around 5.5-6%, while Sentiment has dropped, and even more important - Retail Sales numbers were significantly below the expectations. The core ones were even worse. Of course, we can't conclude on just a single case, but, it is naked the possible contradiction that we've mentioned and that could become the headache for the Fed - high inflation and weak economic growth. Fed has to raise rates because of inflation and can't rise it because of economic weakness at once. This is the primary subject that we have to keep an eye on.
Market overview
The dollar started the week with support as traders bet U.S. inflation data and appearances from several Federal Reserve officials would bolster the case for higher interest rates. U.S.-Russia talks over rising tension in Ukraine also have traders on edge as the two sides seem far apart and failure risks an armed confrontation on Europe's doorstep.
The dollar had met with some selling late last week after a weaker-than-expected headline U.S. job-creation figure squeezed traders out of long dollar positions. But analysts said better-than-expected unemployment numbers still made a good case for hikes sooner rather than later. Fed funds futures have priced an almost 90% chance of a rate hike in March and a more than 90% chance of another one by June and U.S. yields have been surging higher.
Sterling was also marginally weaker on the dollar but has been rallying with bets that the Bank of England (BOE) is likely to be hiking in tandem with the Fed. It was last at $1.3590, near a two-month high, and close to last week's two-year peak on the euro .
Goldman Sachs expects the Fed to raise interest rates four times this year and begin the process of reducing the size of its balance sheet as soon as July. The investment bank, which earlier predicted the Fed would raise rates in March, June and September, now expects another hike in December.
J.P.Morgan on Friday brought forward its forecast for the first rate hike since the pandemic began to March from June, and sees hikes every quarter this year.
Deutsche Bank also said on Friday it expects a total of four Fed rate hikes this year after December jobs data while falling short of market expectations, showed more progress towards maximum employment. The German bank expects Fed's balance sheet runoff to begin in the third quarter.
Rising Treasury yields - the benchmark U.S. 10-year Treasury yield rose to its highest level in almost two years on Monday - also supported the greenback. The yield on 10-year Treasury notes was up 0.9 basis points to 1.778% after climbing to 1.808%, its highest since Jan. 21, 2020. The 10-year yield has risen for seven straight days, its longest streak of gains since an eight-day run in April 2018, and last week had its biggest weekly rise since September 2019.
Richmond Fed President Thomas Barkin said on Monday it is conceivable the central bank could hike in March, according to the Wall Street Journal. On Friday, San Francisco Federal Reserve Bank President Mary Daly said she could see the Fed shrinking its balance sheets after raising rates once or twice.
The dollar edged lower against a basket of currencies on Tuesday after Federal Reserve Chair Jerome Powell's testimony signaled that while the Fed will be normalizing policy it has not made a decision on reducing its nearly $9 trillion balance sheet. Powell noted that policymakers were still debating approaches to reducing the fed's balance sheet, and said it could sometimes take two, three, or four meetings for them to make such decisions
Powell's overall message on Tuesday was less hawkish than some investors had expected, especially in light of recent commentary from some other Fed speakers, analysts said.
"We are going to have to be humble but a bit nimble". Arguably not much of a hint on the timing of rate hike lift-off but investors seemed happy enough with Federal Reserve Chair Jerome Powell's congressional hearing yesterday to eagerly buy the dip on Wall Street.
High inflation and a strong recovery will require the Federal Reserve to raise interest rates at least three times this year, beginning as soon as March, and warrant a rapid rundown of Fed asset holdings to draw excess cash out of the financial system, Atlanta Fed President Raphael Bostic said on Monday.
The dollar fell to a two-month low against a basket of currencies on Wednesday after data, which showed an expected surge in U.S. consumer prices in December, fell short of offering any new impetus for the Federal Reserve's policy normalization efforts.
The consumer price index increased 0.5% last month after advancing 0.8% in November, the Labor Department said on Wednesday. In the 12 months through December, the CPI surged 7.0%, the biggest year-on-year increase since June 1982. Economists polled by Reuters had forecast the CPI gaining 0.4% and shooting up 7.0% on a year-on-year basis. But it was within forecasts, which appeared to reassure investors.
Traders have priced in an about 80% chance of a rate hike in March, according to CME’s FedWatch tool.
Fed fund futures are predicting nearly four rate hikes this year, a seismic change from a few months ago. Long-term rates have been relatively steady. U.S. interest rate pricing is peaking at 1.5% by the third quarter of 2024, far lower than previous U.S. rate tightening cycles.
The dollar fell against a basket of currencies on Thursday to a two-month low, a day after data that showed an expected surge in U.S. consumer prices in December fell short of offering any new impetus for the Federal Reserve's policy normalization efforts.
Nevertheless, traders do not see these inflation readings as urgently shifting an already hawkish Fed too much. With at least three interest rate hikes already in the market price, some investors pared bets on further dollar gains. U.S. producer price inflation slowed in December as the cost of goods fell amid signs that stretched supply chains were starting to ease, hopeful signs that inflation has probably peaked.
As continued high inflation eats further into Americans' pocketbooks, Federal Reserve Governor Lael Brainard on Thursday became the latest, and most senior, U.S. central banker to signal that the Fed is getting ready to start raising interest rates in March.
Philadelphia Federal Reserve Bank President Patrick Harker said he would currently support three interest rate hikes this year, starting from March, and would be open to more if inflation worsens. In an interview with Financial Times, Harker said the central bank had few tools to combat the supply chain problems fuelling inflation, but it should act to slow some of the demand. Harker's remarks echoed the Fed's turn towards inflation-fighting, a shift cemented at a December meeting, where it signaled three rate hikes in 2022.
International Monetary Market speculators exited 2021 with a net long position in the dollar that was close to the largest it has been in two years.
Hedge fund dollar positioning close to the highest levels since early 2020 has added to the selling pressure on the dollar this week, analysts said. U.S. retail sales dropped by the most in 10 months in December, likely the result of Americans starting their holiday shopping in October to avoid empty shelves at stores.
U.S. consumer sentiment soured in early January, falling to the second-lowest level in a decade as Americans fretted about soaring inflation and doubted the ability of government economic policies to fix it, a survey showed on Friday.
The University of Michigan said its preliminary consumer sentiment index fell to 68.8 in the first half of this month from a final reading of 70.6 in December. Lower-income households held a more negative outlook than wealthier ones, with sentiment dropping by 9.4% among households with total incomes below $100,000, but rising by 5.7% among households above that threshold.
The sharper-than-expected drop in sentiment comes as Americans face various headwinds despite an overall strong economy, with inflation topping the list of concerns amid a record level of COVID-19 cases due to the Omicron variant that could in turn prolong high prices.
At a current annual rate of 7.0%, inflation is near a 40-year-high, outstripping wage gains. Consumer price increases have broadened from a handful of pandemic-sensitive categories while supply chain disruptions have continued.
Elsewhere in the survey, consumers raised their expectations for medium-term inflation, another measure the central bank is closely monitoring to ensure that inflation expectations remain anchored.
Policymakers noted that the recent surge in infections caused by the Omicron COVID-19 variant could slow economic growth and prolong the supply chain disruptions that contributed to overly high inflation. The Fed needs to raise interest rates to reduce demand to bring it better in line with crimped supply, said San Francisco Fed President Mary Daly.
Williams said the U.S. economy could grow 3.5% this year, a stepdown from the surge in 2021 but still solid.
The Fed official said he expects the labor market to continue healing as the economy grows, forecasting that the unemployment rate will drop to 3.5% this year.
Pricing pressures may ease as economic growth slows and supply constraints are resolved, Williams said, adding that he expects inflation to drop to around 2.5% this year and close to 2% in 2023. Consumer prices posted their biggest annual rise in nearly 40 years last month. Williams said "gradually" raising interest rates would be the next step in removing accommodation, but the exact timing and pacing of those rate hikes will depend on what happens with inflation and the economy.
The Omicron surge appears to be slowing in areas of the country that were hit first. In the last week, the average daily tally of new cases has risen only 5% in Northeastern and Southern states compared with the prior seven-day period, according to a Reuters analysis. In Western states, by contrast, the average number of infections documented every day has climbed 89% in the past week compared with the previous week. Overall, the United States is still tallying nearly 800,000 new infections a day amid record numbers of hospitalized patients with COVID-19.
Australia has likely neared the peak of its Omicron wave, authorities said on Saturday, but warned daily infections will linger near record levels for "the next few weeks" after more than 100,000 cases were reported for a fourth straight day. More than 1.2 million infections have been recorded this year, compared with 200,000 for 2020 and 2021 combined.
CFTC Report
In general, Speculators increased their net long U.S. dollar positions in the latest week, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar was $19.34 billion in the week ended Jan. 11, compared with a net long of $18.87 billion the previous week.
Speaking on EUR, this week we do not have any decisive changes in overall position. Net longs slightly increase, but on a background of open interest dropping. Besides, overall changes are rather small:
To be continued...
This week the combination of different data was thrilling. The week has started with encouraging J. Powell's speech that calms down investors a bit, but later there are more negative information has appeared. Spreading of omicron variant, rather high inflation data, mixed banks financial earnings results in the IVQ leads to drying of optimism a bit. In fact, this week we've got an important combination of data, the one that we've talked about in the last report - inflation stands high, around 5.5-6%, while Sentiment has dropped, and even more important - Retail Sales numbers were significantly below the expectations. The core ones were even worse. Of course, we can't conclude on just a single case, but, it is naked the possible contradiction that we've mentioned and that could become the headache for the Fed - high inflation and weak economic growth. Fed has to raise rates because of inflation and can't rise it because of economic weakness at once. This is the primary subject that we have to keep an eye on.
Market overview
The dollar started the week with support as traders bet U.S. inflation data and appearances from several Federal Reserve officials would bolster the case for higher interest rates. U.S.-Russia talks over rising tension in Ukraine also have traders on edge as the two sides seem far apart and failure risks an armed confrontation on Europe's doorstep.
The dollar had met with some selling late last week after a weaker-than-expected headline U.S. job-creation figure squeezed traders out of long dollar positions. But analysts said better-than-expected unemployment numbers still made a good case for hikes sooner rather than later. Fed funds futures have priced an almost 90% chance of a rate hike in March and a more than 90% chance of another one by June and U.S. yields have been surging higher.
Sterling was also marginally weaker on the dollar but has been rallying with bets that the Bank of England (BOE) is likely to be hiking in tandem with the Fed. It was last at $1.3590, near a two-month high, and close to last week's two-year peak on the euro .
Strategists at MUFG reckon traders are too hawkish on their rates expectations in Britain but still think sterling will hold its own. "We still expect two rate hikes by the BOE which should keep EUR/GBP under modest downward pressure, which will result in GBP/USD advancing to around the 1.4000 level," they said in an outlook note published over the weekend.
"A number of sell-side firms have revised their Fed forecasts after the NFP (nonfarm payroll) report on Friday," Brad Bechtel, global head of FX at Jefferies, said in a note. With the unemployment rate below 4%, the Fed could probably declare their job on employment 'completed' which does indeed set us up for an even faster period of taper potentially," Bechtel said.
Goldman Sachs expects the Fed to raise interest rates four times this year and begin the process of reducing the size of its balance sheet as soon as July. The investment bank, which earlier predicted the Fed would raise rates in March, June and September, now expects another hike in December.
Goldman Sachs' predicted rate is only modestly above market expectations for 2022, "but the gap grows significantly in subsequent years," chief economist Jan Hatzius wrote in a note published on Sunday.
J.P.Morgan on Friday brought forward its forecast for the first rate hike since the pandemic began to March from June, and sees hikes every quarter this year.
"We believe Fed officials are coming to the same conclusion that the labor market is very tight, making it a tough sell to hold off on the first hike until June, our prior call," the bank's U.S. chief economist Michael Feroli wrote in a note.
Deutsche Bank also said on Friday it expects a total of four Fed rate hikes this year after December jobs data while falling short of market expectations, showed more progress towards maximum employment. The German bank expects Fed's balance sheet runoff to begin in the third quarter.
Rising Treasury yields - the benchmark U.S. 10-year Treasury yield rose to its highest level in almost two years on Monday - also supported the greenback. The yield on 10-year Treasury notes was up 0.9 basis points to 1.778% after climbing to 1.808%, its highest since Jan. 21, 2020. The 10-year yield has risen for seven straight days, its longest streak of gains since an eight-day run in April 2018, and last week had its biggest weekly rise since September 2019.
"It is stalling out a bit, it is just a carryover from last week and we will either get reconfirmation of that when Powell speaks tomorrow or it could go the other way," said Jim Barnes, director of fixed income at Bryn Mawr Trust in Berwyn, Pennsylvania. "We have had a pretty big run-up here over the past week and part of me thinks it is kind of overdone – we get it, it is a hawkish Fed at this point, they are projecting four rate hikes this year."
Richmond Fed President Thomas Barkin said on Monday it is conceivable the central bank could hike in March, according to the Wall Street Journal. On Friday, San Francisco Federal Reserve Bank President Mary Daly said she could see the Fed shrinking its balance sheets after raising rates once or twice.
The dollar edged lower against a basket of currencies on Tuesday after Federal Reserve Chair Jerome Powell's testimony signaled that while the Fed will be normalizing policy it has not made a decision on reducing its nearly $9 trillion balance sheet. Powell noted that policymakers were still debating approaches to reducing the fed's balance sheet, and said it could sometimes take two, three, or four meetings for them to make such decisions
Powell's overall message on Tuesday was less hawkish than some investors had expected, especially in light of recent commentary from some other Fed speakers, analysts said.
"We are going to have to be humble but a bit nimble". Arguably not much of a hint on the timing of rate hike lift-off but investors seemed happy enough with Federal Reserve Chair Jerome Powell's congressional hearing yesterday to eagerly buy the dip on Wall Street.
High inflation and a strong recovery will require the Federal Reserve to raise interest rates at least three times this year, beginning as soon as March, and warrant a rapid rundown of Fed asset holdings to draw excess cash out of the financial system, Atlanta Fed President Raphael Bostic said on Monday.
"Powell defied the hawkish commentary of others on the Fed’s rate-setting committee, suggesting that a quantitative tightening decision will come in the next two to four meetings, with bonds allowed to roll off in an organic manner - as opposed to actively selling securities into the market," said Karl Schamotta, chief market strategist at Cambridge Global Payments in Toronto. This is lifting global risk appetite and spurring flows into yield-sensitive currencies like the Canadian dollar."
The dollar fell to a two-month low against a basket of currencies on Wednesday after data, which showed an expected surge in U.S. consumer prices in December, fell short of offering any new impetus for the Federal Reserve's policy normalization efforts.
The consumer price index increased 0.5% last month after advancing 0.8% in November, the Labor Department said on Wednesday. In the 12 months through December, the CPI surged 7.0%, the biggest year-on-year increase since June 1982. Economists polled by Reuters had forecast the CPI gaining 0.4% and shooting up 7.0% on a year-on-year basis. But it was within forecasts, which appeared to reassure investors.
"The U.S. economy appears ready for interest rate lift-off to start in March," said Joe Manimbo, senior market analyst at Western Union Business Solutions. "The dollar's problem though is that the market already has highly hawkish expectations for Fed policy this year. So as hot as today's CPI price was, it merely reinforced what's already baked in for the dollar and Fed policy," Manimbo said.
"(It's) just a case of the market currently getting too ahead of itself with Fed normalization; we will need to see this inflationary impact from Omicron really play out for the Fed to hike four times and embark on quantitative tightening this year I think," said Simon Harvey, senior FX market analyst at Monex Europe. While we don’t think today’s CPI release will derail the Fed’s likely liftoff in March, continued reports of narrow inflation pressures will likely lead markets to trim expectations of the normalization cycle across 2022 as a whole, which will undoubtedly result in sustained USD depreciation," Harvey said.
Traders have priced in an about 80% chance of a rate hike in March, according to CME’s FedWatch tool.
"Today's inflation report continued to reinforce the theme that gaudy price gains are not standing in the way of demand," said Rick Rieder, BlackRock's Chief Investment Officer of Global Fixed Income and Head of the BlackRock Global Allocation Investment Team. We don't think the Fed will overreact to this condition," Rieder said, adding that he expected the Fed to raise rates in March.
Fed fund futures are predicting nearly four rate hikes this year, a seismic change from a few months ago. Long-term rates have been relatively steady. U.S. interest rate pricing is peaking at 1.5% by the third quarter of 2024, far lower than previous U.S. rate tightening cycles.
The dollar fell against a basket of currencies on Thursday to a two-month low, a day after data that showed an expected surge in U.S. consumer prices in December fell short of offering any new impetus for the Federal Reserve's policy normalization efforts.
"Coming into the new year the dollar positioning was very much skewed to being long," said Mazen Issa, senior FX strategist at TD Securities. Yesterday's inflation numbers, in conjunction with (Fed Chair Jerome) Powell's testimony for his nomination hearing, were basically just in line with what markets had already positioned for," Issa said. "There wasn't anything materially new."
Nevertheless, traders do not see these inflation readings as urgently shifting an already hawkish Fed too much. With at least three interest rate hikes already in the market price, some investors pared bets on further dollar gains. U.S. producer price inflation slowed in December as the cost of goods fell amid signs that stretched supply chains were starting to ease, hopeful signs that inflation has probably peaked.
As continued high inflation eats further into Americans' pocketbooks, Federal Reserve Governor Lael Brainard on Thursday became the latest, and most senior, U.S. central banker to signal that the Fed is getting ready to start raising interest rates in March.
Philadelphia Federal Reserve Bank President Patrick Harker said he would currently support three interest rate hikes this year, starting from March, and would be open to more if inflation worsens. In an interview with Financial Times, Harker said the central bank had few tools to combat the supply chain problems fuelling inflation, but it should act to slow some of the demand. Harker's remarks echoed the Fed's turn towards inflation-fighting, a shift cemented at a December meeting, where it signaled three rate hikes in 2022.
TD Securities' Issa attributed part of the selling pressure on the greenback to technical factors, with the euro on Wednesday rising above the $1.14 level for the first time since mid-November. "Once we got through that $1.14 level, momentum players likely flipped to sell dollars on that move," he said.
International Monetary Market speculators exited 2021 with a net long position in the dollar that was close to the largest it has been in two years.
"The scale of the dollar sell-off must surely be partially indicative of positioning," MUFG analyst Derek Halpenny wrote in a research note.
"Investors appear to be taking the view that the USD has peaked and that Fed tightening moves are priced in and the likes of the euro offer better potential returns down the road," Scotiabank foreign exchange strategists said in a note. We do not concur but have to acknowledge that the USD has suffered a setback — psychologically, at least — by breaking with supportive yield spreads versus its peers and by breaking below the base of its recent consolidation range," they said.
Hedge fund dollar positioning close to the highest levels since early 2020 has added to the selling pressure on the dollar this week, analysts said. U.S. retail sales dropped by the most in 10 months in December, likely the result of Americans starting their holiday shopping in October to avoid empty shelves at stores.
U.S. consumer sentiment soured in early January, falling to the second-lowest level in a decade as Americans fretted about soaring inflation and doubted the ability of government economic policies to fix it, a survey showed on Friday.
The University of Michigan said its preliminary consumer sentiment index fell to 68.8 in the first half of this month from a final reading of 70.6 in December. Lower-income households held a more negative outlook than wealthier ones, with sentiment dropping by 9.4% among households with total incomes below $100,000, but rising by 5.7% among households above that threshold.
The sharper-than-expected drop in sentiment comes as Americans face various headwinds despite an overall strong economy, with inflation topping the list of concerns amid a record level of COVID-19 cases due to the Omicron variant that could in turn prolong high prices.
"While the Delta and Omicron variants certainly contributed to this downward shift, the decline was also due to an escalating inflation rate," Richard Curtin, the survey director, said in a statement. Three-quarters of consumers in early January ranked inflation, compared with unemployment, as the more serious problem facing the nation," he added.
At a current annual rate of 7.0%, inflation is near a 40-year-high, outstripping wage gains. Consumer price increases have broadened from a handful of pandemic-sensitive categories while supply chain disruptions have continued.
Elsewhere in the survey, consumers raised their expectations for medium-term inflation, another measure the central bank is closely monitoring to ensure that inflation expectations remain anchored.
"We continue to believe liftoff in March is increasingly likely. How these debates are settled will likely have implications for post-liftoff rate hikes," Nomura economists said in a report, referring to U.S. monetary policy. In particular, we believe comments regarding earlier runoff and less aggressive rate hikes support our view that the Fed will slow the pace of rate hikes to two per year in 2023."
Policymakers noted that the recent surge in infections caused by the Omicron COVID-19 variant could slow economic growth and prolong the supply chain disruptions that contributed to overly high inflation. The Fed needs to raise interest rates to reduce demand to bring it better in line with crimped supply, said San Francisco Fed President Mary Daly.
"We are going to have to adjust policy to ensure we achieve price stability," Daly said during a New York Times interview on Twitter Spaces. "We want to bridle the economy a little bit."
Williams said the U.S. economy could grow 3.5% this year, a stepdown from the surge in 2021 but still solid.
"Once the Omicron wave subsides, the economy should return to a solid growth trajectory and these supply constraints on the economy should ebb over time," Williams said during a virtual event organized by the Council on Foreign Relations.
The Fed official said he expects the labor market to continue healing as the economy grows, forecasting that the unemployment rate will drop to 3.5% this year.
Pricing pressures may ease as economic growth slows and supply constraints are resolved, Williams said, adding that he expects inflation to drop to around 2.5% this year and close to 2% in 2023. Consumer prices posted their biggest annual rise in nearly 40 years last month. Williams said "gradually" raising interest rates would be the next step in removing accommodation, but the exact timing and pacing of those rate hikes will depend on what happens with inflation and the economy.
The Omicron surge appears to be slowing in areas of the country that were hit first. In the last week, the average daily tally of new cases has risen only 5% in Northeastern and Southern states compared with the prior seven-day period, according to a Reuters analysis. In Western states, by contrast, the average number of infections documented every day has climbed 89% in the past week compared with the previous week. Overall, the United States is still tallying nearly 800,000 new infections a day amid record numbers of hospitalized patients with COVID-19.
Australia has likely neared the peak of its Omicron wave, authorities said on Saturday, but warned daily infections will linger near record levels for "the next few weeks" after more than 100,000 cases were reported for a fourth straight day. More than 1.2 million infections have been recorded this year, compared with 200,000 for 2020 and 2021 combined.
CFTC Report
In general, Speculators increased their net long U.S. dollar positions in the latest week, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar was $19.34 billion in the week ended Jan. 11, compared with a net long of $18.87 billion the previous week.
Speaking on EUR, this week we do not have any decisive changes in overall position. Net longs slightly increase, but on a background of open interest dropping. Besides, overall changes are rather small:
To be continued...
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