PCE? AI? TBD...

The last week of February starts on a quiet note with the USD, major equity indices, and US Treasuries effectively unchanged. All eyes are on inflation data this week with US PCE on Thursday and Eurozone CPI on Friday.

As another week passes, US equities continue to set all-time highs buoyed by robust Nvidia earnings. The outperformance of the so-called “magnificent 7” tech companies in the US has been having consistent spillover effects into other asset classes, Foreign Exchange included. There is no shortage of reasons why the USD should be stronger against all currency pairs, from both interest rate and safe-haven perspectives. Whether it’s large-scale military conflicts in Eastern Europe and the Middle East risking commodity and trade disruptions, consistently strong US economic data, a “higher for longer” Fed, or a sputtering Chinese economy....there are plenty of reasons for risk-aversion.

Yet the Bloomberg Dollar Index is up only 2.45% YtD and still 3.15% lower from last year’s highs, an underperformance that can at least partially be attributed to the AI-driven flame of US tech companies that is making moths of us all. Even mid-February's stronger than expected CPI reading didn’t stand a chance as the initial 1% gain in the USD has since fully reversed and we are right back to where we started.

This week’s question is: will PCE, the Fed’s preferred measure of inflation, finally be able to get the lasting attention of the market? Survey participants have certainly revised their expectations higher after the last CPI reading but the PCE Core Deflator is still expected to drop by 10bps to 2.8% while the equivalent portion of CPI was unchanged at 3.9% earlier this month. A higher-than-expected reading will embolden the recent hawkishness of the Fed and possibly pause the recent run-up in risk markets but whether it will be able to firmly stand in the way of what some are calling “dotcom 2.0” remains to be seen.

Additional thematic highlights as well as this week’s event calendar:

• President Biden will meet with top lawmakers this week to attempt to avoid another government shutdown early next month. The current sticking points are largely related to foreign aid.
• Israel is increasing sovereign borrowing and raising taxes to fund increased defense spending. The Central Bank of Israel kept interest rates unchanged at 4.5%, a 25bp cut was expected.
• Federal Reserve Bank of New York President Williams said it would be appropriate to cut rates later this year, echoing other Fed speakers.

Event Calendar:

• Monday: US New Home Sales; ECB’s Lagarde speaks in European Parliament
• Tuesday: US Durable Goods Orders & Consumer Confidence; Bank of England Governor Bailey speaks
• Wednesday: US GDP 4Q Second release; Mexico Inflation Report; Fed’s Bostic, Collins, Williams speak
• Thursday: US PCE Deflator & Weekly Initial Jobless Claims; Canada 4Q GDP; Mexico Unemployment; Fed’s Goolsbee, Bostic, Mester speak
• Friday: US ISM and UMich Indices; Eurozone CPI & Unemployment; Brazil GDP 4Q; China PMIs; Fed’s Bostic & Daly speak

EUR/USD is higher on the day and 0.7% higher versus this time last week, even as the market prices in higher odds of the ECB cutting ahead of the Fed as implied in interest rate markets. The odds of an ECB cut by June are at 100% versus 75% for the Fed yet the pair is almost 1.5% higher than the post-US CPI lows seen earlier this month. Thursday’s CPI prints in France, Spain, and Germany as well as Friday’s print for the Eurozone as a whole may move those odds significantly. Core CPI in the Eurozone is expected to drop 0.4% to 2.9% on a year-on-year basis.

USD/CAD is slightly higher on the day and week, reacting mildly to a softer-than-expected CPI print last week as well as dovish statements by Prime Minister Trudeau who said he is optimistic that the Bank of Canada will start bringing down interest rates this year. In addition, crude oil prices are down 2.4% compared to this time last week. Canadian 4Q 2023 GDP is to be released on Thursday, with an increase to +0.8% expected versus the prior –1.1% reading.

GBP/USD is higher on the day and 0.7% higher than this time last week as 2024 rate cut bets decrease. 70 basis points of cuts are expected through the end of the year, down from 100bps recently. This move is a divergence from the UK’s continental neighbor. The ECB is expected to cut rates a full 2 months ahead of the Bank of England at current interest rate market pricing. The economic highlights of the week consist of house price and manufacturing PMI data this Friday.

USD/MXN is unchanged on the day and slightly higher versus this time last week as the Peso largely sidesteps commodity weakness. The highlight of the week will be Wednesday’s inflation report from the Central Bank that may shed some color on the start of the bank’s cutting cycle. Some have suggested this may begin as early as March which, while certainly far ahead of expected Fed cuts, would not be dramatically surprising given the loftiness of the current 11.25% overnight rate.

USD/BRL is lower on the day but effectively unchanged from this time last week as the real’s strength is muddied by the legal issues of former President Bolsonaro who was forced to surrender his passport. The current administration led by President Lula da Silva, himself jailed prior to re-election, is investigating coup attempts by the former President. The pair has traded somewhat sideways over the last 60 days, although in a 4.5% band.