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Outlook: The big US release today is the trade deficit, mostly ignored for several years now but a major factor in decades past and a key factor in classic FX analysis. The idea is that a country with a deep deficit needs to devalue to get back to something like trade balance, but the dollar’s role as reserve currency screws up that model. Besides, US companies have long preferred to operate overseas and sell directly to their customers rather than export from the US. This grew out of tariffs and transportation costs that have since changed dramatically.  

US trade numbers lost their relevance to the FX market a long time ago, but are still relevant to GDP (even if nobody ever found a way to factor in overseas output by US companies, which goes to the country they are operating in, not the US). We get the Atlanta Fed’s GDP Now forecast for Q4 tomorrow. The last version was a drop to 2.8% from over 4%. Assuming the deficit increases (via imports), that’s a drag on GDP.  

We see that word “pivot” everywhere now–China is pivoting away from zero-Covid, the Fed is pivoting away from aggressive rate hikes. This is wishful thinking in both cases.  

The changes in China are minor so far and while some additional changes are possible, they will be minor, too. The question is whether they will add up to changing the grim growth figures now expected–China used to get 6-8% growth and the Covid policy pulled that down to perhaps 3.5% (IMF estimate). Maybe some Covid relaxation can pump that up to 4.5-5.5%?  

The Fed has more latitude, to be sure, but a 50 bp hike coming in eight days is hardly a “dovish pivot,” especially when the Fed has gone to great lengths to assert they will keep hiking until they are sure inflation is whipped. From 3.75-4.0% now, that means 4.75-5.0% at the least and maybe more, so probably a full one percentage point to go. In what way is this either dovish or a pivot? It’s neither.  

The problem is that a reality check could generate an outsized reaction. We just saw one reality check in the form of the ISM service sector yesterday defying forecasts and coming in strong.  

Of real concern at the Fed is any evidence of the inflation mentality becoming entrenched and demonstrating that with ongoing wage hikes. To be fair, the rise in average hourly earnings is 5.1% y/y, less than inflation, but if inflation is falling, so should wage hikes.  

Realistically, labor is weak and it’s the employers who decide on wage hikes, revealing their own inflation expectations. A related point was made by Fed Brainard, who pointed out that even after supply-side shocks have faded, “… an extended period is likely to call for monetary policy tightening to restore balance between demand and supply…Even in the presence of pandemics and wars, central bankers have the responsibility to ensure that inflation expectations remain firmly anchored at levels consistent with our target.” Wage growth at about 5% does not deliver that anchored inflation expectation.  

In fact, wage pressures–if they keep up–will lead the Fed to raise rates beyond the 5% max now expected. The Fed has warned that wage growth will need to slow to combat high inflation, but the latest numbers show it’s rising–to 5.8% annualized in the three months to Nov from 3.9% annualized in the three months to October. That is probably the big takeaway from Friday’s nonfarm payrolls, not the actual number of jobs.  

So far demand from rising wages is not causing inflation, but last week Powell said “Recent pay gains were around 1.5 to 2 percentage points above what would be consistent with the Fed’s 2% target. ‘We want wages to go up. We want wages to go up strongly. But they’ve got to go up at a level that is consistent with 2% inflation over time.”  

Add the wage issue to the relentless materialism of the American consumer, and as supply-side inflation abates, the demand side can kick in. Those who see inflation falling and the Fed cutting rates by Dec 2023, as we wrote about yesterday, are almost certainly dead wrong.  

But let’s say inflation seems to be falling back and next spring the Fed does pause, with cuts expected by Dec. Why would we not expect the economy to pick up steam, halting the inflation drop–and getting the Fed back on its high horse by year-end? That would push recession fears into 2024. Prematurely ending the tightening mode is the Fed’s nightmare. It should be ours, too.  

After the RBA and BoC do their thing, we have to wait for PPI on Friday. The modest 25 bp hike in Australia and dovish words expected from Canada tomorrow are setting a tone. US PPI may dip and restore the sanguine attitude about the Fed in 2023. But even as the ISM service sector was a reality check and caused a reversal in FX (not to mention equities), we think it will be a one-day wonder. This is a risky attitude because you never know how and why sentiment shifts, but the interest rate mavens have been fighting the Fed-watchers for months, and it’s hard to see them giving up after only one little punch.  

A little shocking is the Bloomberg report that Goldman sees a soft landing. On Friday the strategists wrote that sector positioning in equities shows the soft landing assumption. “Professional investors overseeing a total of $5 trillion are loading up on bets that a recession can be avoided, according to a study from Goldman Sachs. The positions amount to wagers that the Federal Reserve can tame inflation without creating a recession, often referred to as an economic soft landing.” This is scary because if these investors and managers start seeing data that points to no soft landing, they can panic. But not yet. In fact, most analysts expect a Santq Claus rally.  

Of interest in the news is the European Commission, with support from the US, contemplating a ban on new investments in Russia’s mining sector. The FT Reports this would be the 9th sanctions package that could come into being late next week after talks. In addition, the package would include export controls on technologies used in Russian arms factories, a ban on transactions with three more Russian banks, and sanctions against another 180 individuals. The point: Russia is increasing isolated and impoverished. Historically, sanctions take a very long time to get the desired effect. Look at sanctions on S. Africa over apartheid–several decades. But they are effective in the end.  

Forecast: the dollar should resume its downward move, if with less momentum and some whipsawing, as in the CAD (now deeply oversold). Commentary about the AUD is total confusion. If China is coming back, the AUD should do well and the bottom should be in.    

Tidbit: The NYT has a story on Germany belatedly embracing heat pumps now that natgas prices have doubled.

We thought heat pumps do not work when the outdoor temp is 40 degrees F or lower. But apparently the German version operates just fine in colder weather using newish technology and are already used in really cold places like Finland and Norway. Germany is playing catch-up. Why is this not universally known News?  

Political Tidbit: Today is the Georgia runoff vote for Senator between the trainwreck lying ex-football player and the sane and smart church minister. Weirdly, it’s a tight race, although turnout is spectacular. It’s a sad commentary that either outcome would be consistent with what we see in the body politic today. This is the country where Trump can call for terminating the Constitution and this outrage is not enough to prevent the party members he leads from saying they would vote for him. 


This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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This morning FX briefing is an information service, not a trading system. All trade recommendations are included in the afternoon report.

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