Weekly view - Trust but verify

Slowing US inflation and European economic resilience were reflected in currency movements last week. In the US, the drop in the December consumer price index (CPI) led to hints from Fed officials that the next rate hike (at the start of February) will be 25bps instead of 50bp, pushing the US dollar lower against the euro. Meanwhile ‘soft’ data in the US continues to be mixed. The University of Michigan consumer sentiment index for January hit an eight-month high on easing inflation worries, but small-business sentiment for December fell to a six-month low. This week, we will pay special attention to the release of US retail sales figures for December. US banks kicked off the 4Q earnings season last week. The banks’ revenues were boosted by higher rates and strong consumer spending, but provisions also increased to cover potential loan losses (although loss rates on credit cards for now remain below pre-pandemic levels). Overall, banks’ guidance points to further downward revisions in earnings expectations. Interestingly, JP Morgan indicated that it would have to hike deposit rates to attract retail money – a clear threat to the generous interest-rate margins banks have been earning since the rise in base rates. In other news, the North American Leaders Summit prioritised investment in semiconductor manufacturing – consistent with our ‘friend-shoring’ theme for 2023.

The mood is improving in Europe, with lower energy prices set to be reflected in reduced import costs and a better trade balance. Preliminary German GDP for 2022 came in at 1.9%. China’s reopening is also helping European sentiment. Consequently, the euro rose last week to its highest level since June 2022. We stick to our scenario of a gradual decline in the US dollar in 2023. 

We may be close to peak covid contaminations in China’s big cities, so the country’s economic recovery could be faster than expected. While re-opening and measures to support the property sector have prompted a rally in USD-denominated Asian credit in general, our preference goes to high-quality investment-grade bonds. The Chinese government has moved to take ‘golden shares’ in Alibaba and Tencent, giving it a big say in terms of both companies’ strategic decisions. “Trust but verify” seems to be the Chinese authorities’ motto. Markets will pay a lot of attention to the Bank of Japan’s (BoJ) policy meeting this week. The BoJ reportedly spent almost JPY10 trn last week defending the yield on Japanese government bonds, while CPI in the Tokyo region reached 4% in December, its highest level since 1982. It is probably too early to expect a full exit from the BoJ’s policy of yield-curve control, but market participants will look for indications of increased flexibility in the BoJ’s approach that could pave the way to policy normalisation. We are overweight the yen, which should be the main beneficiary of any such move.