The first half of January has shown a dislocation between rate expectations and data in the US. The two most important data points for the Federal Reserve, the labor and CPI inflation figures, turned out to be hotter than expected. The PPI was a little weaker than consensus on Friday, but that’s not enough to justify markets’ reluctance to price in Fed easing. Fed funds futures curve prices at 21 basis points of cuts in March and 168 basis points at the end of the year.
Our view remains that the Fed will not start cutting before May and that the total easing package will be 150 basis points. Consequently, the rally in short-term dollar rates appears overdone, and weakness at the front end of the dollar curve should support some dollar recovery. However, we suspect that the data may prove insufficient to trigger a USD rebound for now; The consensus view of a dollar decline later this year appears to be prompting investors to sell dollar rallies. Additionally, the Fed probably needs to send a clearer message that the most recent data does not justify the kind of aggressively dovish view implied by money market prices. There are a few more Fed speakers scheduled for this week, but perhaps dollar bears will want to hear what Fed chief Jerome Powell, who is not scheduled to speak until the Jan. 31 FOMC announcement, has to say.
By the way, the US data calendar is not very busy this week. Retail sales and inflation expectations from the University of Michigan will attract the most attention along with jobless claims, which came in well below expectations last week, reinforcing the narrative of a still tight labor market. We believe the dollar will be boosted more by other events than this week’s data, barring any major surprises. First, the election results in Taiwan have once again raised the sensitive issue of Taipei-Beijing relations, with tensions between the two seen as a major risk to Asian and global risk sentiment this year. The dollar could benefit from some exposed emerging market currency outflows. The situation in the Gulf also appears quite volatile following US and UK military operations last week, although the impact on oil prices has been muted so far.
Internally, we will closely monitor market reaction to the extension of corporate tax relief currently being discussed in the US Congress. The impact of fiscal support may be negative for risk sentiment – and positive for the dollar – as markets see a higher risk of sticky inflation and a lower likelihood of the Federal Reserve cutting rates.
We believe the dollar is more at risk of a rally than a further correction from these levels, although the chances of another week of range-bound trading in the FX market (DXY is still hovering around the 102/103 region) are high. .