Market Brief: Monetary Easing Hopes Fade

CalendarJanuary 17, 2024

The dollar is holding near a one-month high and risk appetites are deteriorating as investors ratchet monetary easing expectations down in the face of a concerted jawboning campaign from central bankers.

Odds on a rate cut at the Federal Reserve’s March meeting are down to less than 60 percent after Governor Christopher Waller warned policymakers would be “methodical and careful” in lowering borrowing costs. In a speech given yesterday morning, Waller disappointed investors expecting a repeat of previous rate-cutting cycles by saying “With economic activity and labor markets in good shape and inflation coming down gradually to 2 percent, I see no reason to move as quickly or cut as rapidly as in the past”. We think his words, combined with guidance from other officials like Dallas’ Lorie Logan, point to a March decision to begin reducing the pace of balance sheet roll offs, with the first cut coming in May, and a quarterly cadence emerging thereafter.

The yuan is on the defensive after a raft of data showed the Chinese economy turning in a mixed performance in late 2023 as domestic demand flatlined, property development slowed, and export markets softened. The full-year expansion in gross domestic product hit 5.2 percent - topping the government’s 5-percent target - and industrial output climbed 6.8 percent in December from the year prior, while fixed-asset investment rose 3 percent. But retail sales grew 7.4 percent, missing market expectations, home sales plunged more than 20 percent, and consumer prices fell 1.5 percent in the fourth quarter.

The British pound is gaining ground after an unexpectedly strong inflation print helped reduce the impetus for easing at the Bank of England. Consumer prices defied forecasts by rising at an annual rate of 4 percent in December, up from 3.9 percent in November, and services inflation - closely monitored by policymakers as a better measure of underlying price pressures - accelerated to 6.4 percent from 6.3 percent in the prior month. Odds on a rate cut at the Bank’s May meeting are now below 55 percent, down from 80 prior to the release.

Headlines emerging from an interview with European Central Bank president Madame Lagarde roiled the euro earlier this morning. In an interview with Bloomberg, she said a rate cut by the summer looked “likely” - triggering a brief selloff - but then warned  “we have to stay restrictive for as long as necessary” to keep inflation on its downward trajectory. The common currency recovered as she said, “The risk would be we go too fast and have to come back and do more," and gained more ground when her colleague Klaas Knot later told CNBC: “The more easing the markets has already done for us, the less likely we will cut rates, the less likely we’ll add to it”.

Canadian policymakers have been - mercifully - on mute, but soft underlying details in yesterday’s inflation report are driving cross-border rate differentials into closer alignment, and a broad-based worsening in risk appetite is weighing on the loonie. After a brief pop on stronger-than-expected headline inflation yesterday morning, the exchange rate fell through the 1.35 threshold against the big dollar, and looks technically poised to remain north of that mark through today’s session.

Markets believe US headline retail sales accelerated in December, even as underlying demand softened. Receipts at retail stores, online sellers and restaurants are expected to climb 0.4 percent from the month prior, up from 0.3 percent in November as unusually-warm weather encouraged shopping activities. Control group sales - which exclude auto, gas, restaurant, and building materials purchases - are seen slowing to 0.2 percent from 0.4 percent in the previous period - but an upside surprise is possible, given the improvement in business and consumer sentiment recorded near year end.


Karl Schamotta

Karl Schamotta

Chief Market Strategist

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