Last week’s US inflation report confirmed the downward trend in price pressures and sent financial markets worldwide soaring on the hope that Fed hikes will soon stop. 2023 has gotten off to a very optimistic start, as the good news on inflation are added to fading fears of a European recession and the Chinese post-COVID reopening. Stocks worldwide soared, bonds rallied, and the dollar suffered as traders sold-off safe-havens, ending the week down against every major currency except the Swiss franc. The 2023 party in emerging market currencies rolled on, fuelled by rising commodity prices and increased risk appetite.

This week is relatively light in data. A critical Bank of Japan meeting looms on Wednesday, given hints that the Bank of Japan is ready to ditch its position as a dovish outlier among the major central banks. The key question will be whether the trends in place so far for 2023, i.e., rallying risk assets, diminishing worries about the inflation outlook and a falling dollar, stay in place as markets digest the positive inflation news from last week. Traders’ attention will be focused on the numerous speeches by the world’s central bankers at the Davos economic forum later in the week. We expect diverging content and tone from ECB and Fed speakers, given the developing gap between the trends in core inflation in the Eurozone (still rising) and the US (slowly falling).


The UK economy continues to outperform gloomy expectations. It managed to eke out 0.1% growth in the month of November, defying expectations for a mild contraction and casting doubt on calls that the UK is already in recession. Sterling did not react much to the news, and it largely tracked the euro in its rally against the dollar. The UK will provide a couple of the few major data points in the coming week, with the publication of the latest labour report on Tuesday, and the December inflation data on Wednesday. We will be paying particularly close attention to the core index. So far, as is the case in Europe, we have not seen this key indicator exhibit the kind of welcome downward trend we are witnessing in the US.


The main news of the week out of the Eurozone was the large upward surprise in industrial production for November. While the number is old by now, it makes it quite unlikely that the Eurozone entered recession in the winter of 2022, in line with our views and contrary to the gloomy sentiment. The continued fall in energy prices is further buoying sentiment on the Eurozone economy, and the common currency outperformed every G10 currency last week, save the yen. We will pay close attention to ECB President Lagarde’s speech at the Davos forum in the coming days. The need for Eurozone rates to catch up with those in the US, and the further upside to the bloc’s economy from China’s reopening, remain the pillars of the bullish case for the euro.


Last week’s US inflation report came in almost exactly as expected, and that was good news for markets. The monthly headline number fell for the first time since May 2020, while the key core inflation index, more persistent and a better predictor of future inflation than the headline, rose by only 0.3%. The latter has been on a clear, albeit gentle, downward path since last summer, though it is still at levels far above the Fed targets. It now seems likely that overnight rates in the US will not rise above 5% before the Fed adopts a wait and see attitude, with financial markets eyeing two additional 25bp hikes in February and March before the FOMC ends its tightening cycle. That said, we still think that the prospect of rate cuts lies far into the future, certainly not before 2024.