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More Fed Officials Signal Patience, US CPIs Take Center Stage

Summary

Headlines that China’s Vice Premier will visit the US later this month for further trade negotiations may have kept hopes over a final accord elevated.

Something evident by another day of risk-on trading.

Further dovish remarks by Fed officials, including Chair Powell, may have helped somewhat as well.

As for today, focus is likely to turn to the US CPI data for December, especially after Powell noted that inflation remains and under control.

Original Source 

Powell and Co. Patient on Future Hikes, Focus Turns on US Inflation

The dollar traded mixed against the other G10 currencies on Thursday. It gained the most against the safe-havens CHF and JPY, with the former also feeling the heat of the SNB’s announcement that it recorded a CHF 15bn loss last year. The best performing currencies were once again the commodity-linked NZD and AUD.

USD performance G10 currencies

The activity in the FX sphere suggests that market sentiment remained supported for another day. Major EU and US indices closed their sessions in the green, with the positive sentiment rolling into the Asian session today. Although this week’s trade negotiations between China and the US did not result in any final accord, they finished on a positive note, leaving the door open for further talks. Indeed, even though Trump cancelled its planned trip to Davos, where we expected some talks to take place, headlines that China’s Vice Premier, the nation’s top trade negotiator, will visit the US later in the month may have kept hopes over a final accord elevated.

Another round of Fed comments may have also contributed somewhat to the already sanguine market sentiment, with Fed Chair Jerome Powell reiterating that the Committee has the ability to be patient on further rate increases, as it continues to monitor how the economy evolves. “Especially with inflation low and under control, we have the ability to be patient and watch patiently and carefully” the Fed Chief said, while when asked over the Fed’s predictions of 2 hikes throughout the year, he said that “There is no such plan”. “That was conditional on a very strong outlook for 2019, an outlook that may still happen,” he added. His remarks were echoed by Vice chair Richard Clarida later in the day. The Vice Chair said, “I believe patience is a virtue and is one we can today afford.” Bullard and Evans spoke for a second consecutive day, with Bullard repeating that rate rises need to stop, and Evans noting once again that the Fed has “good capacity to wait”. A wait-and-see stance was also adopted by Richmond President Thomas Barkin, who said that the economy will tell when it is time to return to neutral.

Given that this round of comments was more or less in line with what we have heard yesterday, the dollar did not react much. After all, it tumbled yesterday, with the highlight being Bostic’s comments over a rate cut. Although investors have slowly priced out the probability for such a move according to the Fed fund futures, they still don’t see the Committee hitting the hiking button this year. They anticipate a 16% chance for something like that to happen by December.

Fed funds futures market vs Fed expectations

As for today, focus is likely to turn to the US CPIs for December. Expectations are for the headline rate to have declined below the Fed’s objective of 2%, while the core one is anticipated to have held steady. Specifically, headline inflation is forecast to have slowed to +1.9% yoy from +2.2%, while the underlying rate is seen unchanged at +2.2% yoy. In our view, this pattern suggests that the further decline in the headline rate may be mainly owed to the latest decline in oil prices. So, having that in mind, we expect all the attention to be on the core measure, which if stays unchanged, is unlikely to alter much expectations with regards to the Fed’s future plans. Following the latest bunch of dovish remarks by several Fed policymakers, and especially Powell’s point that inflation is low and under control, a decent pick up is needed for the market to start examining the idea of at least one hike this year.

US CPIs inflation

Having said all that, we have to repeat that although the greenback has no reasons to gain at this point and may continue drifting south for a while more, we view the risks surrounding its somewhat longer-term performance as asymmetrical and slightly tilted to the upside. The currency has already fallen on expectations that the Fed will not hike this year. Thus, with most Fed officials, even though patient, not scrapping the idea of at least one hike and staying data driven, data pointing that the economy is not slowing as many are afraid and that inflation may start picking up steam again could prompt investors to bring their expectations higher and thereby, the dollar could strengthen. Let’s not forget that the employment report showed wages accelerating to +3.2% yoy in December, which could lead to higher inflation in the not-too-distant future.

On the other hand, more moderate economic indicators could keep the currency under pressure, but with the market not pricing any hikes this year, they may have diminishing effects. Unless we see huge disappointments, something that may revive expectations with regards to a rate cut and thereby, accelerate the slide in the greenback.

Yesterday, we also go the minutes from the latest ECB meeting, which revealed that some policymakers argued for changing the language over the economic outlook to say that the risks surrounding the bloc’s growth are “tilted to the downside”. That said, the euro barely reacted to the minutes, perhaps given that the case for changing the growth language as early as at this meeting was already reported by sources last month.

AUD/USD – Technical Outlook

AUD/USD traded higher during the Asian morning Friday, breaking above the resistance (now turned into support) zone of 0.7200. Following last week’s “flash crash” spike lower, the pair has been in a recovery mode, and on the 4th of the month, it managed to emerge above the downside resistance line drawn from the peak of the 4th of December. Since then, the price structure has been of higher peaks and higher troughs, with the rate now trading above all three of our moving averages. So, having that in mind, we would consider the near-term outlook to be positive.

The current risk-on market environment may allow Aussie to continue attracting flows, while expectations for no Fed hikes this year may keep the greenback under selling interest for a while more. Thus, we believe that the break above 0.7200 may have opened the way towards the high of the 13th of December, at around 0.7245, the break of which could trigger extensions towards 0.7290, a resistance marked by the inside swing low of the 30th of November.

Looking at our short-term oscillators, we see that the RSI turned up again and now looks ready to cross above 70, while the MACD, at extreme positive levels, looks able to move back above its trigger line. These indicators suggest that AUD/USD could regain some upside speed soon and corroborate our view for some further advances.

On the downside, we would like to see a clear dip below 0.7115 before we start examining whether the bulls have abandoned the field, at least in the near term. Such a move could bring the rate back below all three of our moving averages and may initially aim for the 0.7070 area, which proved to be a good resistance from the 24th until the 31st of December. Another break below 0.7070 could extend the slide towards 0.7015.

USD/JPY – Technical Outlook

USD/JPY edged north yesterday, after it hit support near the 107.80 zone. At the time of writing, the pair is flirting with the downside resistance line drawn from the high of the 17th of December. Although the dollar may stay weak in light of the recent dovish remarks by several policymakers, we see the case for the yen to be weaker, due to the current boost in risk appetite. Thus, we will closely monitor the price action near the aforementioned line, as an upside break may add some credence to our view.

A clear break above that line and the 108.50 barrier may add a positive spin to this pair and could encourage the bulls to target Tuesday’s high, at around 109.10. If they prove strong enough to overcome that territory, the move would confirm a forthcoming higher high on the 4-hour chart and may set the stage for extensions towards the psychological zone of 110.00.

Our short-term oscillators suggest that USD/JPY may have the necessary momentum to break above the downside resistance line. The RSI turned up and appears ready to cross above 50 soon, while the MACD, although slightly negative, lies above its trigger line and points up.

In order for the bias to shift back to the downside, we believe that a break below yesterday’s low of 107.80 is needed. Such a move could signal that traders want to keep the rate below the downside resistance line and may open the path towards the 107.00 zone, or the 106.65 barrier, which supported the pair back on the 9th and 11th of April.

As for the Rest of Today’s Events

During the European morning, the UK industrial and manufacturing production for November are coming out, as well as the monthly GDP for the month. Both industrial and manufacturing production are expected to have rebounded 0.3% mom and 0.4% mom respectively, after sliding 0.6% and 0.9% in October. This would drive both yoy rates slightly higher, but still keep them in negative territory. The case for a slight increase in these yoy rates is supported by the manufacturing PMI for the month, which rose to 53.6 from 51.1.

UK industrial production vs manufacturing PMI

With regards to the monthly GDP, given the tumble in the services PMI for November, a slowdown would not come as a surprise to us, as the service sector accounts for nearly 80% of the UK GDP. The UK trade balance for November is scheduled to be released as well and expectations are for the nation’s trade deficit to have narrowed somewhat. In any case, as we noted several times in the recent past, we expect the pound’s faith to be dictated by UK politics instead of economic data. With elevated uncertainty over what happens after May’s deal gets rejected next week, which we see as the most likely outcome with what we have in hand at the moment, we maintain the view that the pound may stay pressured and that any rallies are likely to be short-lived, at least until the fog clears out.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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