Overview: The dollar softer against the G10 currencies ahead of today’s CPI report and the FOMC meeting the concludes tomorrow. Emerging market currencies are most mixed. The Hungarian forint leads the complex with around a 1% gain on news of a preliminary deal struck with the EU. The South African rand is the worst performer, off around 0.8%, as impeachment proceedings against Ramaphosa proceed. Global equities are mostly higher today after the strong advance seen in the US yesterday. Chinese equities are a notable exception as profit-taking sets in after the strong rise amid reports of a surge in Covid cases. Europe’s Stoxx 600 is up about 0.3% in late morning turnover, while US futures are enjoying a firmer tone. European benchmark yields are slightly firmer, though 10-year Gilt yields have jumped nearly seven basis points to 3.26%. The US 10-year yield has come back a bit softer after yesterday’s rise. At 3.60%, the yield is almost two basis points lower. Gold has stabilized following yesterday’s nearly $16-decline. It is about $5 firmer near $1786.50. After falling every day last week January WTI is extending its recovery today. It rose 3% yesterday and is up another 1% today to about $74 a barrel. The cold spell in the US is lifting natgas prices for a fifth consecutive session. It is up nearly a quarter in this run-up. Europe’s benchmark is snapping a three-day slide and is up a little more than 4% today. Iron ore is softer after falling nearly 2% yesterday. March copper is rebounding about .6% after it too lost about 2% yesterday. March wheat is trying to snap a five-week slide. It is up nearly 1.2% on top of yesterday’s 2.8% rally.

Asia Pacific

The anticipated move away from its zero-Covid policy was more bullish for Chinese stocks and currency that the actual thing. Reports indicate a steep surge in cases is taking place. One of China's top Covid advisors warned in a Caixin op-ed piece that a large initial wave should be expected followed by weaker second and third waves. Reports suggest regionally there are different sub-variants of the infection. Last week, the former deputy head of China's Center of Disease Control and Protection warned that in the first wave as many as 60% of the population may contract Covid. Zero-Covid caused its own disruptions, and the rapid dismantling looks likely to cause another set of disruptions.

Last week, it was the Netherlands that seemed to come around to tighter export controls on advanced chipmaking equipment shipment to China. News reports suggest that Japan has also now agreed in principle to the same. This makes the US measures announced in October more effective. To be sure, it is not just about the cutting-edge technology, but to ensure the US and its allies maintain a large gap over China. The exports bans are aimed at 14-nanometer or smaller chip technology, which is at least three generations behind the latest that are commercially available. China's most advanced chipmaker, Semiconductor Manufacturing International Corp, is understood to be capable of making 7-nanometer chips with 14-nanometer technology according to reports. 

The dollar edged a little past yesterday's high (~JPY137.85) earlier today to record a new high for the month but stalled in front of JPY138.00. The US 10-year Treasury yield rose for the third consecutive session yesterday, the longest advance in a month (for a cumulative gain of nearly 20 bp after falling almost 16 bp in the previous two sessions) but is a little softer today. The 20-day moving average is near JPY138.25, and the greenback has not traded above it since November 4. A dip in late Asian turnover slightly below JPY137.35 found new buyers. The Australian dollar was turned back from the $0.6800 area yesterday and fell to about $0.6730 to test the 20-day moving average. It is consolidating with a firmer bias in yesterday's range. There are options for almost A$710 mln struck at $0.6800 that expire today. Many participants see the Aussie as a G10 proxy for China, suggesting its potential vulnerability. Meanwhile, the greenback traded on both sides of yesterday's narrow range against the Chinese yuan and is still little changed around CNY6.98. It is the fifth consecutive session that the dollar has not traded above CNY7.0. The PBOC set the dollar's reference rate at CNY6.9746, while the median projection in Bloomberg's survey was for CNY6.9777.

Europe

The UK employment data does not appear to change the likelihood that the Bank of England delivers a 50 bp hike at Thursday's meeting. The swaps market has about a 25% chance of a 75 bp hike discounted, practically unchanged from a week ago. The ILO measure of unemployment ticked up to 3.7% in the three months through October from 3.6% in the three months through September. Payrolls rose by 107k in November after increasing by a revised 79k in October (initially 74k). Employment, based on the labor force survey rose by 27k in the three months through October, well above the median forecast in Bloomberg's survey for a 17k decline. Average wages, excluding bonuses rose 6.1% in the three months through October from 5.8% in September. Including bonus pay, income edged up to 6.1% from 6%. Private sector pay slowed slightly, while public sector (where the strike activity is concentrated) to by 2.7% in the three months through October from 2.2%. The takeaway is the labor market continue to hold up well in the face of the weakening economy.

Germany's ZEW investor survey improved in November, perhaps helped by the 8.6% rally in the Dax last month after a 9.4% rally in October. It reached its best level since June in late November. The assessment of the current situation improved to -61.4 from -64.5. It was the second consecutive monthly improvement and the first back-to-back gain of the year, although it did not match expectations. On the other hand, the expectations component surpassed expectations by improving to -23.3 from -36.7. It is the third consecutive monthly gains in expectations, which are at their best level since last October.

The clash between the EU and Hungary has been resolved. Although there has been a shift to qualified majority voting, there ae still a number of areas that require unanimity. Hungary had been taking advantage of this to force the EU's hand in freeing up funds earmarked for Budapest, but which have been held back due to rule-of-law violations and corruption charges. Perhaps the Qatar World Cup scandal that rocked the EU Parliament encouraged the compromise. The last heads of state summit of the year will be held on Thursday to approve the deal. The quid pro quo will allow aid to Ukraine in exchange for a reduced amount of funds to be denied Hungary. EU members agreed to approve Budapest's pandemic-recovery plan that frees up 5.8 bln euro in grants. And rather than suspend 7.5 bln euros over persistent corruption/graft issues, which the EC had initially recommended, Hungary would lose only 6.3 bln euros. Still, there are several criteria the must be met for Hungary to draw on the funds and this is not anticipated until Q2 23 at the earliest. 

The forint is the third worst performing emerging market currency this year (~-16.9%) behind the Argentine peso (~-40%) and the Turkish lira (~-28.7%). November CPI accelerated to 22.5% year-over-year from 21.1% in October. Its base rate has been at 13% since September. Like many other countries in the region, the surge in energy prices have seen Hungary's trade surplus switch into a deficit. In the first ten month of the year, Hungary has recorded a trade shortfall of 6.81 bln euros. In the Jan-Oct period last year, Hungary reported a 2.02 bln euro surplus. In the first ten months of 2019, the trade surplus was 3.9 bln euros.

The euro is in about a third of a cent range today against the dollar mostly below $1.0560. There are a little more than 1 bln euros in options at $1.06 that roll off today. We assume that the nearly 990 mln euro of options that expire today at $1.0550 have been neutralized. Yesterday's low was about $1.0505, and the pre-weekend low was closer to $1.0480. Sterling is also in a narrow roughly half-cent range, mostly below $1.2300. The recent high (December 5) was about $1.2345. It is the fifth session of higher lows, so far. Yesterday's low was around $1.2310.

America

The summer dispute between the US and OPEC+ on the outlook for oil prices appears to have been resolved in OPEC+ favor. January 23 WTI has fallen from above $108 a barrel in early June to about $70 in recent days, the lowest since the very start this year. The average price of retail gasoline in the US fell to new lows of the year near $3.25 a gallon. It peaked near $5 in mid-June.

Arguably, there is an asymmetrical risk associated with today's CPI. A higher-than-expected 0.3% monthly gain may produce a bigger market reaction than a softer number given that the 10-year yield is at the lower end of its where it has traded in the past three months (~3.50%). The two-year yield has been trending lower since peaking November 4 at 4.80%. The median forecast in Bloomberg's survey has the year-over-year pace slowing to 7.3% from 7.7% and a peak of 9.1% in June. The core rate is expected to slow to 6.1% from 6.3%. It peaked in September at 6.6%.

We have suggested that the terms of the debate have shifted away from when US inflation will peak to have fast it will come down. The median forecast in Bloomberg's survey sees CPI at 4.3% at the end of next year from 7.7% in October. It puts the PCE deflator at 3.4% and as we have shown by comparing the September 23 and December 23 Fed funds futures, fully pricing in a quarter-point cut at late next year. The median view in the Fed's Summary of Economic Projections (dot plot) is for the PCE deflator to be at 2.8% at the end of next year. Despite its lower inflation projection, it has insisted it will not cut rates until 2024. In the last five monetary cycles, which go back until 1989, the average time between the last hike and the first cut has been about 6.5 month, in a range of two-months to 13 months. If the last hike in penciled in for the May 3 meeting next year, a cut in at the December 13 meeting may not be such a stretch.

The US dollar remains well within the CAD1.3560-CAD1.3700 range that has dominated for the past week. It found a bid in late Asian turnover in front of CAD1.3600. Initial resistance is seen in the CAD1.3640-50 area. There are options for around $675 mln struck at CAD1.3700 that expire today. Another set for nearly $1.4 bln expire today at CAD1.3560. The greenback jumped to MXN19.9185 yesterday, its best level since the end of October. The peso lost ground even though October industrial output was strongest than expected (0.4% vs. median forecast in Bloomberg's survey for -0.1% and the September series was revised slightly higher). The peso's weakness since recording its best level since February 2020 at the end of November appear to be an adjustment of positioning as domestic triggers do not seem present. The next important psychological level is MXN20.00 and the 200-day moving average a little above MXN20.04. 

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