The U.S. economy got off to a bad start this year, with activity in both the manufacturing and services sectors falling in January, even as upbeat U.S. macro data for the fourth quarter of last year capped losses in the dollar index. Momentum in the U.S. economy appears to have slowed markedly as rising interest rates erode demand.
The Bank of Canada announced this week that it may pause interest rate hikes, sending a major signal that the policy rates of major central banks are approaching the peak of the current rate hike cycle. The Fed may further slow the pace of rate hikes to 25 basis points next week.
The euro zone’s two largest economies, Germany and France, have had limited downward momentum since the beginning of the year, suggesting that a recession is by no means a foregone conclusion, and the bullish outlook for the euro has been maintained. In contrast, news surrounding the UK has been mixed, weighing on the bullish bias for the pound.
U.S. economy remains resilient in fourth quarter
The U.S. dollar index fell slightly by 0.15%, hitting an intraday low of 101.500 since the end of May last year. The good fourth-quarter macro data limited the dollar’s decline. In fact, the Commerce Department reported that the world‘s largest economy grew at an annualized rate of 2.9% in the fourth quarter, compared with a previous estimate of 2.6%.
In addition, the number of Americans filing new claims for unemployment benefits last week hit the lowest level since April last year. Unemployed workers are finding it easier to find a new job than to apply for government benefits. That partly reflects the stagnant pace of government handouts in a world of rising prices and wages.
But the start of 2023 has been disappointingly weak, with business activity contracting sharply again in January. Although slower than in December, the drop was one of the largest since the global financial crisis, reflecting a decline in activity in both manufacturing and services. Businesses said they were concerned about the lingering impact of high prices and rising interest rates, as well as persistent concerns about supply and labor shortages.
Most investors expect the Fed to further slow its rate hikes to 25 basis points next week. Last year, the Fed slowed the pace of rate hikes to 50 basis points in December after raising rates four times in a row by 75 basis points.
ING economists: “We doubt the market is ready to increase short dollar positions ahead of next week’s FOMC meeting, which could be positive for the dollar if the Fed dampens the market’s current expectation of two cumulative 50 basis point rate hikes this year. event risk.”
Bank of Canada signals rate hike pause
USD/CAD fell about 0.5% this week, hitting an intraday low of 1.3302 since mid-November last year. The Bank of Canada raised interest rates by 25 basis points to 4.5% this week as scheduled. But at the same time issued a signal to pause interest rate hikes. Analysts believe that, given the current economic outlook, the January policy meeting may be the swan song of the Bank of Canada’s current rate hike cycle.
In its policy statement, the Bank of Canada noted that it is likely to keep rates at this level as it assesses the impact of cumulative rate hikes. There is growing evidence that restrictive economic policies are slowing economic activity, especially household spending.
“Markets are likely to interpret this as the end of the current rate hike cycle, which could dampen people’s interest rate fantasies and put pressure on the Canadian dollar,” said Elisabeth Andreae, currency analyst at Commerzbank.
There’s no reason to doubt the euro’s bullishness right now
The euro rose more than 0.3% against the U.S. dollar, hitting a new high of 1.0929 since late April last year. The euro zone’s two largest economies, Germany and France, have seen limited downward momentum since the start of the year, suggesting a recession is by no means a foregone conclusion, although businesses remain cautious about the outlook.
Joe Hayes, senior economist at S&P Global Market Intelligence, said that from the latest French PMI data, it can be seen that input price inflation has eased further and business confidence has picked up. The French labor market also continued to show its resilience, with job growth accelerating to a three-month high.
Phil Smith, director of economics at S&P Global Market Intelligence, said that after six consecutive months of decline, German service sector activity even returned to growth, albeit only marginally. In addition to some easing of supply chain pressures, inflation continues to moderate. Optimism has returned as recession risks ease.
The market expects the European Central Bank to raise interest rates by 25 basis points next week. ECB Governing Council member Gabriel Makhlouf became the last policy maker to make hawkish remarks before the ECB’s new policy meeting, suggesting a 50 basis point rate hike. He added that they need to raise rates again at the March meeting.
Ulrich Leuchtmann, head of foreign exchange and commodity research at Commerzbank, believes it is too early to be skeptical about the euro. would not be affected. In this case, one could even make a case that the euro is positive. The foreign exchange market seems to be less concerned about whether it is really only a 25 basis point hike in March than whether the ECB has already made a commitment , as the latter would desensitize, which would be detrimental to the euro. The purpose of the ECB’s remarks was likely to dispel that impression. In my view, they were successful. For now, we expect to see at some point Market disillusionment, but it’s a long, long way from that moment.”
UK macro news mixed
GBP/USD hit resistance after hitting a high of 1.2447 since early June last year, and is currently down about 0.15%. Mixed news surrounding the UK weighed on the pair’s bullish bias. UK Chancellor of the Exchequer Jeremy Hunt’s willingness to boost economic growth failed to impress sterling buyers.
Despite heavy criticism from fellow Conservatives, Hunt has defended his stance on tax increases. He will pledge on Friday to tackle the country’s weak productivity with post-Brexit fiscal reforms to boost growth. But he will also insist on tax increases, angering some MPs in his Conservative Party.
Economists at Commerzbank expect the pound to continue to struggle for the time being. Nowhere in the realm of their economists’ forecast is the outlook as gloomy as in Britain, and the Bank of England is facing a particularly difficult choice. It is hard to imagine that the Bank of England can complete its anti-inflation mission without a recession.
Economists at Canadian Imperial Bank of Commerce believe that the market may expect the Bank of England to tighten monetary policy too much this year, eliminating the upside for the pound in the coming quarters. “The Bank of England appears set to extend policy tightening to 10 in a row; remember, they started the cycle in December 2021. However, we are currently expecting 102 basis points of rate hikes in 2023, with the market expecting The final rate will be close to 4.50%, which is still too aggressive. With further large-scale public sector strikes planned in February, broad macroeconomic activity and overseas confidence in UK assets are being tested.”
Japan won’t exit yield curve control policy immediately
USD/JPY rose for the second week in a row, but the gain of about 0.35% was significantly smaller than the previous week. Japan’s senior diplomat for monetary affairs, Masato Kanda, warned that large unilateral fluctuations in the exchange rate cannot be tolerated. This suggests that the Bank of Japan will not exit the yield curve control policy immediately.
Commerzbank analysts said: “The BOJ may be correct in assuming that high inflation levels are temporary and that inflation will soon fall below the BOJ’s target. However, it is increasingly clear that the government wants to end this consensus. Fumio Kishida intends to discuss this consensus with Kuroda’s successor, which makes the question of who will be Kuroda’s successor even more important. If so far, someone leaves support Kuroda’s policy, that would be bad for the yen; if someone criticizes Kuroda’s policy, the yen could appreciate further sharply.”
“While the Bank of Japan’s apparent flexibility on its current policy stance has shifted the balance of risks in favor of further yen strength, without an immediate exit from yield curve control, we are more optimistic relative to widespread recession fears,” Goldman Sachs said. A more constructive view of U.S. growth in 2023 should keep USD/JPY on hold in the near term.”
Goldman Sachs added: “Taken together, we see little room for the yen to depreciate in the short term and have brought forward the time for appreciation.” Down to 132, 125 and 125, previously 136, 136 and 126.
Economists at Rabobank believe: “In the next few weeks, Prime Minister Fumio Kishida will nominate the next governor of the Bank of Japan. This may bring a series of surprises, because there is a possibility that speculators may have to accept The outlook for the new governor may not be very different from the old one. In our view, there may be some room for some changes in the BoJ’s policy in the coming months. However, this may not be material. Assuming the BoJ’s The yield curve control policy has been tweaked in the spring and we forecast USD/JPY at 128 three months from now, but given the risk of keeping policy on hold again, expect volatility around the March policy meeting.”