Dollar Steadies Ahead of Retail Sales Data

• December retail sales data will be the data highlight; as things stand, the U.S. economy remains firm
  
• Monthly U.K. data dump came in firmer than expected; market sees full speed ahead for the BOE; reports suggest there is a growing sense of urgency on both sides regarding Brexit talks; RUB remains under pressure after talks with NATO hit a dead end
  
• Reports suggest that the BOJ is debating how to begin its messaging for an eventual rate hike; recent reports add an element of uncertainty to next week's BOJ meeting; China reported December trade data; BOK hiked rates 25 bp to 1.25%., as expected
  

The dollar has steadied ahead of retail sales data but remains vulnerable. DXY is basically flat after three straight down days. Still, it has traded at the lowest level since November 10 near 94.713 and a test of the November 9 low near 93.875 is possible. The euro rally ran out of steam just below $1.15, while sterling is having trouble breaking above the 200-day moving average near $1.3735 currently. USD/JPY is trading below 114 for the first time since December 21 on reports about BOJ removing accommodation (see below)

AMERICAS

December retail sales data will be the data highlight. Headline sales are expected at -0.1% m/m vs. 0.3% in November, while sales ex-autos are expected at 0.1% m/m vs. 0.3% in November. The so-called control group used for GDP calculations is expected flat m/m vs. -0.1% in November. Of note, retail sales data surprised to the upside for a few months before the November downside miss. December import/export prices, IP (0.2% m/m expected), November business inventories (1.3% m/m expected), and preliminary January University of Michigan consumer sentiment (70.0 expected) will also be reported today.

As things stand, the U.S. economy remains firm. Atlanta Fed's GDPNow model is tracking 6.8% SAAR growth in Q4, up from 6.7% previously and 2.3% in Q3. Bloomberg consensus sees 6.0% SAAR in Q4, slowing to 4.0% in Q1 and 3.6% in Q2. Obviously, markets will be looking for any signs that the higher than expected inflation is taking a toll on growth. Higher food and energy costs hit the poorest households disproportionately, forcing a downward adjustment in their discretionary spending.

We continue to believe that markets are underestimating the Fed. Despite the hawkish tilt, markets still see a terminal Fed Funds rate of 1.75%. Four hikes this year would be followed by two hikes next year. With the economy pretty much at full employment now, such a timid rate path just doesn't make any sense. With the Fed increasingly concerned about wage inflation feeding into price inflation, it will clearly have to move into a more restrictive stance than what markets are expecting. Indeed, a 1.75% terminal rate would likely result in a negative real rate that remains accommodative. The dollar rally has taken a pause but we are not yet ready to throw in the towel on our strong dollar call.

EUROPE/MIDDLE EAST/AFRICA

Monthly U.K. data dump came in firmer than expected. November GDP rose 0.9% m/m vs. 0.4% expected and a revised 0.2% (was 0.1%) in October, IP rose 1.0% m/m vs. 0.2% expected and a revised -0.5% (was -0.6%) in October, construction jumped 3.5% m/m vs. 0.6% expected and a revised -1.7% (was -1.8%) in October, and services index rose 0.7% m/m vs. 0.5% expected and 0.4% in October. The trade balance unexpectedly shifted to a surplus of GBP626 mln vs. expectations for a deficit of -GBP2.5 bln. October was also revised to a surplus of GBP151 mln vs. a deficit of -GBP2.03 bln previously. The real sector have been disappointing of late and so this batch is welcome news. That said, it seems likely that the data soften again in December due to omicron.

Yet the market sees full speed ahead for the BOE. WIRP suggests nearly 90% odds of another hike February 3, followed by hikes at very other meeting that would take the policy rate to 1.25% by year-end. However, swaps market is starting to price in the possibility of a fifth hike this year to 1.50%. We continue to think that this pricing overstates the BOE's need to tighten, as headwinds are likely to come from Brexit, higher energy costs, and fiscal tightening.

Reports suggest there is a growing sense of urgency on both sides regarding Brexit talks. The U.K. and the EU has reportedly agreed to intensify the ongoing post-Brexit negotiations over Northern Ireland. This comes as Foreign Secretary Truss took the U.K. side for the first time this week after the departure of David Frost. Two days of talks were held this week in the U.K. and the plan is to meet again on January 24. A joint statement with EU negotiator Sefcovic said "We share a desire for a positive relationship between the EU and the U.K. underpinned by our shared belief in freedom and democracy." The change in tone is welcome but the Irish Protocol remains a major sticking point for both sides.

The ruble remains under pressure after talks with NATO hit a dead end. Russian officials said they still hope for more talks but it appears that the West is standing firm against most of Moscow's demands that would undoubtedly increase its sphere of influence. Reports suggest the U.S. is pressuring its allies in Western Europe to agree to potential sanctions on Russia if the situation worsens. We believe the ruble's fate is entirely in Russia's hands. If it invades Ukraine, all bets are off as we fully expect the West to enact the harshest sanctions, including (but not limited to) kicking Russia off SWIFT and banning any investment in Russian assets. Of note, the U.S. Senate fell short of passing a measure imposing new sanctions on the Nord Stream 2 gas pipeline by a 55-44 vote; 60 votes were needed.

ASIA

Reports suggest that the Bank of Japan is debating how to begin its messaging for an eventual rate hike. Sources hinted that a hike could come before it reaches its 2% inflation target, adding that the bank "never committed" to keep rates on hold until inflation moves that high. We find it strange that any BOJ officials would make such comments when the yen has been strengthening as it has been in recent days. Other reports suggest that the BOJ will upgrade its assessment of inflation risks, but any talk of tightening seems way too premature.

All of these recent reports add an element of uncertainty to next week's BOJ meeting. That said, the market hasn't really reacted to this latest news, as the swaps market still sees no BOJ tightening through 2024. Updated forecasts will be key to determining how serious the bank is about tightening. The bank is playing with fire here as such talk will only add to yen strength. USD/JPY is trading below 114 for the first time since December 21 and is on track to test the December 17 low near 113.15. After that is the November 30 low near 112.55.

China reported December trade data. Exports rose 20.9% y/y vs. 20.0% expected and 22.0% in November, while imports rose 19.5% y/y vs. 27.8% expected and 31.7% in November. As a result, the trade surplus came in higher than expected at $94.5 bln and pushed the full year total up to $676 bln. Export strength is welcome news for the region, but the drop in imports warns that activity is slowing due to the spread of the omicron variant. Studies suggest the Sinovac vaccine is not effective against omicron and so policymakers have been relying on hard lockdowns to contain any outbreaks. This will surely have a significant impact on the economy and is feeding into expectations of imminent stimulus.

Bank of Korea hiked rates 25 bp to 1.25%., as expected. There was one dissent in favor of steady rates. Governor Lee downplayed the back-to-back hikes, noting that policy remains accommodative and would not be considered tight even with rates at 1.5%. Lee also acknowledged that faster hikes by the Fed would be an important factor for BOK policy, though he added that he's not greatly concerned about the overall impact of Fed normalization. Lee said the bank now expects inflation to stay over 3% for "a considerable time" and is one of the main factors behind the need for higher rates. CPI rose 3.7% y/y in December, down a tick from the November peak but nearly double the 2% target. Swaps market is pricing in 75 bp of further tightening in 2022 that would take the policy rate to a peak of 2%. However, given the BOK's more hawkish stance, we see upside risks here.

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