27 December 2023

CNY

Will markets be rabbiting-on about China?

As China welcomes in their New Year, there is increasing optimism the country can recover economically, especially given that they are now finally emerging fully from three years of government-induced pandemic isolation. This should also be good news for the global economy, and especially those countries that have the highest exports to China, such as Asean* countries and Australia, with the latter relying on China for much of its commodity-based exports.

Recent data has highlighted just how much China needed to re-open, with GDP (at 3%) expanding at its weakest pace in 2022 since way back in the 70’s, although the actual figure did exceed many international forecasts. The Chinese government had targeted a much more optimistic 5.5% increase. More recently, there were also some improvements over expectations in manufacturing and retail sales through December, potentially implying that the Chinese consumer may already be benefitting from the relaxation of pandemic restrictions toward the end of the year.

After falling from 6.3000 to 7.3000 throughout the past year, the yuan has also embarked on a worthy recovery against the greenback, rising to 6.7800, albeit in-line with broader currency gains against the dollar. Looking ahead, this trend could well continue given broader market optimism on the outlook for the Chinese economy, and the persistent trend of dollar weakness.

*Asean countries include Indonesia, Malaysia, Philippines, Singapore and Thailand

GBP

The pound has been contained within a fairly tight trading range over the past week, with GBP/USD only briefly moving below 1.2300 (low 1.2263), whilst also failing to break over 1.2450 after several attempts. The latest batch of data releases have hardly helped the pound’s cause, with December’s data for UK public sector borrowing reflecting the accelerating cost to the government of both ongoing debt interest payments, and energy bill assistance programmes. The former saw the government having to foot a painful £17.3bn bill through December alone, a figure clearly impacted by those ongoing BoE rate hikes.

Overall, government public sector net borrowing hit £24.7bn through the past month (a December record), nearly £15bn more than the same month a year ago, and £7bn more than had been earmarked by analysts. It is not all doom and gloom, however, with the latest factory price data helping to boost signs of softening in inflation, which may help to cap the ultimate terminal rate for the BoE, as well as softer energy prices since the summer helping to reduce the government’s cost with assistance programmes. These factors should help to smooth overall borrowing costs as we progress through the spring. The latest PMI readings also reflected some softness versus expectations in the composite and services components, although there was a surprising beat for manufacturing.

Next week will be dominated by the first BoE meeting of the year. It is a tough balancing act for Andrew Bailey and the rest of the MPC, on the one hand inflation is softening, but by no means anywhere near where it needs to be at. However, the UK has been struggling against a wall of negativity, with huge increases already to the cost of living and what seems like half of the country out on strike at any given moment. Further hikes in rates will only make the tough times even tougher for those that need it the most, as higher interest rates add to their woes, so after what is likely to be another 25bps rate hike, further hikes may be a tough ask.

As for the pound, well the powerful trend of a weakening dollar and that surging EUR/USD (see EUR) will help to ensure that GBP/USD may remain buoyant for the most part. A move over 1.2500 looks the next big challenge for the sterling bulls to attack. GBP/anything else is another matter, and given the weak backdrop, the pound may find the going a little tougher, especially against the resurgent single currency.

EUR

It has been a strong start to the year for the single currency, with better data for the region helping to underpin the ongoing commitment from the ECB to maintain their aggressive path of rate hikes. That set of improving data really has helped the cause, with the latest PMI readings (mostly) beating estimates and reflecting solid improvements. Both German and Euro area services PMI’s are now above the key 50 (economic expansion) territory, reflecting increased optimism. Strong gains in the German ZEW survey also highlighted improving sentiment and business conditions.

Talking of increased optimism, German Chancellor, Olaf Scholz, bravely predicted this week that Germany will now avoid a recession. Of course, with spot gas prices now running at about a third of the level they were at their peak, the predicted commitment that the government in Germany would have had to made to assist consumer energy bills, will now be a fraction of previous estimates. With signs of recovering manufacturing and consumer optimism increasing, the chancellor may well be onto something.

Christine Lagarde and her team at the ECB are still using every opportunity to highlight the need for further 50bps rate hikes, and markets now fully expect that the ECB will raise rates in the Euro area by 100bps over the next couple of months. Contrast that against a Fed that may hike US rates by 50bps (at most) during the same period, and it is easy to see how rate dynamics have shifted in favour of the single currency.

That has all helped to underpin the move in EUR/USD, and gone are the days of markets calling for another test of parity again, most analysts are now predicting the next move to be a test of the 1.1000 region. Saying that, the single currency has struggled to hold onto gains above 1.0900 over the past week. GBP/EUR has not quite played to the same tune, and having slipped to test support at 1.1300, rallied back over 1.1350 alongside the recovery in GBP/USD (see GBP).

Next week sees the release of both German and region-wide inflation, data which could well add further support to the ECB’s argument to remain hawkish.

USD

The recent trend of ongoing dollar weakness has shown few signs of abating through this week. With overall market sentiment remaining positive, equities and broader risk assets rallying, the dollar has struggled to make any meaningful gains, even if the greenback has avoided marking new cycle lows as the dollar index (DXY) remains steadfast above 101.00.

It has been a fairly positive week on the US data front, with the latest PMI survey beating estimates across the board, although all components still remain well below the key 50 threshold. The latest growth figures also slipped during Q4 from 3.2% to 2.9%, but markets had been expecting a steeper decline, and given that it was the first release, that number could be subject to amendments down the line. The Fed’s preferred inflation gauge, Core PCE (personal consumption expenditures), also saw a big drop from 4.7% to 3.9% (QoQ/Q4).

The Core PCE may help to solidify market expectations that the Fed will hike rates by 25bps, at their first meeting of the year next week, a level which had dominated the minds of Fed speakers before we hit the quiet period at the end of last week. Of course, given that 25bps is already well and truly priced into markets, the big driver on the day will be about what the Fed say around future rate hikes, and any emerging chances of a pause. Just two days after the fed will be the next payrolls data, which could further reflect a softening labor market.

Back to the dollar, and with the single currency buoyant (see EUR) and USD/JPY remaining under pressure as markets price in the ever-increasing probability that the BoJ will abandon YCC (yield curve control) over the coming months, it might take a particularly hawkish Fed to turn the tide in favour of a stronger dollar. Next week looks like being a volatile one indeed.

CAD

The Bank of Canada (BoC) raised Canadian interest rates by a further 25bps this week to 4.5%, marking the eighth consecutive meeting in which they have raised Canadian interest rates, since their initial 25bps hike this time last year. The really juicy news came in the shape of their accompanying statement, in which they confirmed that they will now be pausing rate hikes, as they assess the impact of their cumulative moves so far on the broader economy.

On balance, the decision to confirm the pause probably made the conclusion slightly more dovish than had been predicted, although BoC governor Tiff Macklem suggested that it was far too early to be talking about interest rate cuts, despite recent easing of inflationary pressures in Canada. The BoC highlighted the impact of their hikes on household spending, with slowing activity and a weakening housing market justifying their more cautious outlook.  

Looking ahead, next week’s November growth figures are set for release, with early estimates predicting a slowdown in monthly growth from 0.1% to 0%. As for the Loonie, well the recent range of 1.3300 – 1.3500 has held throughout this week, which is a bit of a surprise to us, given the event and data risks. Whilst oil has been trending higher, the moves have also not been aggressive enough to really impact the short-term profile for the Loonie, so it might take next week’s Fed decision, to force a breakout.

AUD & NZD

An unexpected jump in quarterly headline Australian inflation, up from 1.8% to 1.9%, when markets had been expecting a dip to around 1.6%, helped to send the Aussie to a new cycle high, as markets instantly re-evaluated the prospects for Australian rate hikes. AUD/USD briefly moved as high as 0.7142, a level that has not been traded since the middle of last year. The principal drivers to the increase in inflation were energy costs and a rebound in tourism.

The government has since said that it had hoped that price growth had peaked, and they may have a point, given the lagging nature of the data set. At 7.2% (YoY/Q4), inflation in New Zealand may be slightly lower than the likes of the US. Europe and UK. However, Chris Hipkins, who became the new prime minister just this week, suggested that his new government will need to do ‘whatever it takes’ to reduce the burden of higher prices on household budgets.

NZD/USD also managed to mark a new cycle high through this week, moving as high as 0.6530. Next week sees the release of the latest New Zealand unemployment data.