Markets continue to celebrate the apparent defeat of inflation by sending stock markets worldwide to fresh all-time highs. Last week, commodity and emerging market currencies joined the party, and traditional safe-havens like the Japanese yen, the Swiss franc and (this time) the dollar suffered, while the New Zealand dollar topped the table of world currencies. The celebratory mood in financial markets is all the more remarkable given that Federal Reserve cuts continue to be pushed back into the future. This week will be all about inflation. The US inflation report is now the most important single economic release worldwide, and the January data to be released this Tuesday will be the main market focus this week, followed by the equivalent UK report the following day. In keeping with the theme that the ‘last mile’ in the inflation fight will be the hardest, markets are expecting a monthly print in the critical US core sub index consistent with inflation in a 3.5-4% annualised range. Expect serious fireworks in financial markets in response to any meaningful surprise.
Sterling reacted positively to the risk-seeking mood in markets last week, and a decent upward revision to the January PMIs of business activity didn’t hurt either. The better than expected tone in economics news, and the highest rates in the G10, have propelled sterling to the second position in the G10 year-to-date rankings, behind only the US dollar. This week’s employment and inflation reports will be critical for the future path of Bank of England policy. Employment data, in particular, has tended to surprise on the upside recently, which could further support the pound. Thursday’s fourth quarter GDP data will also be closely watched by market participants, given that this could show that the UK economy entered into a technical recession in the second half of 2023. Economists are eyeing another modest quarterly contraction, following the 0.1% downturn in Q3.
As the Eurozone economy stagnates in spite of a labour market at essentially full employment levels, markets are expecting the European Central Bank to be the first in cutting rates. Even here, however, the timing continues to be pushed back, as communications from Governing Council members largely strike a hawkish tone, notably chief economist Lane last week, who said that the bank would need more confidence that inflation was heading to target before lowering interest rates. As things stand, an April rate cut is now only 50% priced in, which we think is consistent with both ECB rhetoric and economic fundamentals. This week there is little economic data out of the Eurozone, but a number of ECB council members are scheduled to speak, including president Lagarde on Thursday. Fourth quarter GDP data will be released on Wednesday, although this is a revision from the preliminary estimate.
Now that markets have backed away completely from a March Fed cut, and the US economy continues to fire on all cylinders, chair Powell’s relentless pushback against market pricing for early rate cuts has been completely vindicated. Last week’s blowout ISM business activity reports provided further evidence that pricing pressures are not yet tamed. Macroeconomic news, in general, is surprising to the upside (Citigroup’s US Economic Surprise Index has risen to its highest level since early-November), while the Atlanta Fed’s GDPNow estimate is pointing to growth above 3% annualised.