Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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US PCE Preview: March rate cut bets could pick up again
Charu Chanana
Chief Investment Strategist
Summary: Market is seemingly focused on resilient growth in the US economy, and has pared March rate cut expectations for the Fed. While growth metrics remain mixed, focus will likely return to disinflation with core PCE this week pointing towards a move to 2% inflation by mid-2024. Soft core PCE below 0.2% MoM for December will likely increase the odds of a March rate cut again, pushing yields and dollar lower.
Market has now pared back expectations of a March rate cut to 40% after the pushback from Fed officials including Waller. Markets still remain convinced about a disinflationary trend being in place. However, after several months, the key question still is – whether the US economy will go into a recession?
Hard and soft data continues to be in divergence. Soft data coming from sentiment surveys, such as those from the regional Fed branches, have shown steep declines and send out recessionary warnings. The S&P Flash PMIs for January reiterated a rosy outlook for the US economy last night. Manufacturing PMI rose back into expansionary territory to 15month highs of 50.3 while services PMI accelerated to 52.9 from the prior 51.4.
But hard data, such as jobless claims, retail sales or NFP continue to hold up well. Q4 GDP due today may as well soften from Q3, but is likely to remain around 2% which does not corroborate with a recession. However, there are two things of note here:
- Hard data is usually more backward-looking compared to soft data, and takes longer to capture the turn in economic cycles due to lags to monetary policy
- Hard data has been subject to sharp downward revisions over the last year
In-line with the above trends, both GDP and PCE data due this week is likely to signal steady disinflation and a resilient economy.
Strong GDP growth is market’s base assumption, but if the actual print comes in above expectations, that could still boost the dollar. Annualized GDP is expected to cool to 2% in Q4 from 4.9% previously which was boosted by Swiftonomics. The DXY index could target the 103.80 level again if the actual print is above 2%, ahead of 50% fibo retracement at 104. A softer GDP growth may be seen by markets as an orderly slowdown of the economy, and is unlikely to spark sharp concerns of a slowdown. We believe dollar could be pushed lower but could remain supported at 50DMA at 102.96 in that scenario.
Core PCE however remains a bigger focus as it is the Fed’s preferred inflation measure. Fed expectations have somewhat been mis-aligned to the rapid disinflationary forces at play, given the upside surprise in CPI recently and a pushback to easing expectations from Fed officials. If rent inflation started to cool, inflation metrics could cool faster than expected and could again increase the odds of March rate cut. Core PCE for December is expected to come in at 0.2%, which will be the third consecutive month of a sub-0.25% print. This trend is associated with confidence about the YoY inflation returning to 2%, and could be a drag on yields and dollar. USDJPY could target this week’s lows of 146.66 while 1.0950 could be on target for EURUSD. Any upside surprise in core PCE, however, could be something that market is extremely sensitive to as this could serve as a further pushback to rate cut expectations, sending yields and dollar higher. Still, 150 and 1.08 could serve as levels to buy the dip in yen and euro respectively.
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Other recent Macro/FX articles:
24 Jan: Markets could start to price in a Trump presidency
24 Jan: ECB Preview: Will EUR pay heed to the pushback to April cut expectations?
23 Jan: Podcast: Central banks and key figures run the show
22 Jan: Weekly FX Chartbook: Soft-landing hopes and US exceptionalism will remain at play
19 Jan: A reality check on Bank of Japan’s policy normalization and JPY appreciation expectations
15 Jan: Weekly FX Chartbook: UK data will be a test of GBP resilience
12 Jan: Markets ignore CPI uptick, Mideast tensions could fuel haven and oil-related FX
9 Jan: FX Quarterly Outlook: High yielding currencies will start to lose their appeal
9 Jan: US CPI Preview: Markets could be sensitive to an upside surprise
8 Jan: Macro and FX Podcast: Upcoming US CPI figures, USD momentum, and musings on China
8 Jan: Weekly FX Chartbook: Room for tactical gains in USD
18 Dec: Macro and FX Podcast: Watch USD sentiment and BoJ hints on rate policy
18 Dec: Weekly FX Chartbook: Dollar to end 2023 in a bearish trend
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