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USDJPY tumbled on less hawkish Powell talks about QT and signs of inflation easing

calendar 13/01/2022 - 20:17 UTC

USDJPY made a multi-year high around 116.36 on 4th Jan amid increasing policy divergence between Fed and BOJ coupled with some reversal of safe-haven flows as the concern of an all-out Omicron lockdown fades. Fed is now actively preparing the market from tapering to tightening; i.e. winding up of QE, successive rate hikes and quantitative tightening (balance sheet reduction). Fed may hike 3-4 times in 2022-23 and shrink its $9T balance sheet by almost 50% over the next few years in a bid to control uncontrolled inflation and also to prepare itself for any next cycle of economic crisis. Fed will never adopt any NIRP stance unlike its counterpart on the other side of the Pacific (BOJ).

In fact, on the other side of the Atlantic (Europe/EU) as well as Pacific (Japan), ECB and BOJ consistently failed to normalize their crisis-era super accommodative monetary policies on the excuse of deflation. The policy divergence between Fed and ECB/BOJ is making USD stronger and helping the greenback to remain as the ‘King’ (growth currency rather than funding currency).

As a result of hawkish FOMC minutes, elevated inflation, and substantial progress of US employment, the market is now assuming faster Fed tightening. Thus US bond yields are soaring and approaching 1.80%. But at the same time, elevated inflation in the EU, Japan, and the U.K. coupled with the indication of withdrawal of pandemic monetary stimulus by ECB, BOJ as well as BOE is also supporting EUR, JPY and GBP against USD. And after a terrible NFP headline for December (mixed report), EURUSD surged, while USDJPY slid (after making a multi-year high around 116.36). GBPUSD also jumped as BOE may hike multiple times in 2022 and as Omicron restriction was proved to be less severe than earlier expected.

USDJPY slips more to 114.00 Thursday as Fed Chair Powell sounded less hawkish on QT (Quantitative Tightening/ Balance Sheet shrinkage/run-off) than some of his FOMC colleagues. In his renomination Senate testimony, Powell emphasized inflation control by QE tapering, successive rate hikes, and also QT. But Powell signaled that Fed will discuss the modalities of QT in the next two-four meetings and may go for the same later this year (2022).

This means that Fed will decide on QT by March or June’22 meeting, while several Fed Governors already jawboned the market for March’22 liftoff and QT soon after that. Thus USD slips, EUR, JPY, Gold, and equities jumped.

On Wednesday, all focus was U.S. inflation data. Although, Fed already acknowledged as inflation substantially higher than its 2% target, the rate hike condition for inflation has already been achieved. But the pace of Fed tightening (rate hikes and QT) may also depend upon the pace of inflation in 2022; i.e. whether Fed will hike from March or June’22 and go for QT accordingly.

The BLS data shows that the annual inflation (CPI) rate in the U.S. accelerated to 7.1% in December (y/y), at the highest pace in 40-years (since June 82), but in line with market expectations and higher than 6.8% recorded in November. Energy was the biggest contributor to the gain but the rise was smaller than in November, with gasoline prices surging lower. Inflation accelerated however for shelter; food, namely food at home; new vehicles; used cars and trucks; apparel; and medical care services. On a sequential basis, the headline CPI eased to +0.5% in December from +0.8% in November and slightly higher than the market expectations of +0.4%. Thus sequentially, there was a big drop in CPI.

The U.S. core CPI jumped +5.5% in December (y/y), accelerating from a +4.9% rise in November, slightly above market expectations +5.4%, and was highest since Feb’91 (30-years). On a sequential basis, the core CPI increased +0.6% in December from +0.5% in November and higher than the market expectations of +0.5%.

Inflation spiked in 2021 due to pandemic-induced supply constraints, soaring energy costs, labor shortages, increasing demand and a low base effect from 2020; i.e. it was a mismatch between higher demand and lower supply amid the deluge of fiscal as-well-as monetary stimulus, pent/catch-up demand, higher consumer spending in consumer durable goods in absence of pandemic disrupted service coupled with lingering supply chain disruption for COVID related restrictions/lockdowns.

Further, on Thursday, BLS flash data shows that U.S. PPI eased to +9.7% in December (y/y) from November reading +9.8% and lower than the market expectations +9.8%, but highest since data was first calculated in 2010. On a sequential (m/m) basis, the U.S. PPI increased +0.2% in December from +1.0% in November and was lower than the market expectations +0.4%.

But the U.S. core PPI increased +8.3% in December (y/y) from +7.9% in November and higher than the market expectations +8.0%. On a sequential basis, the U.S. core PPI increased +0.5% in December from +0.9% reading in November and was right on the expectations +0.5%.

Overall, at a glance, if the U.S. core PCE index increased around +0.6% sequentially in December in line with core CPI, then the annual (y/y) rate should be around +5.0%. And considering the present correlation between core CPI and core PPI inflation, the January core CPI may also remain elevated around +6.0%. Thus despite some moderation of inflation sequentially, it would be sticky in January too, especially amid lingering Omicron/COVID disruptions in China, the main source of the supply chain for the U.S. as well as Europe. This will keep pressure on Fed for a faster tightening to control the demand side of the inflation equation.

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On Thursday, all focus was also on U.S. jobless claims, which serves as a proxy for the unemployment trend:

The U.S DOL flash data shows the number of Americans filing initial claims for unemployment benefits (UI-under insurance) rose to 230K in the week ending 8th January from 207K in the previous week and higher than the market expectations of 200K amid the limited effect of Omicron disruptions, especially for the contact-sensitive/consumer-facing service industry (like leisure & travel and education sectors). The 4-week moving average of initial jobless claims, which removes week-to-week volatility, rose to 210.75K in the week ending 8th January from 204.50K in the previous week.

The continuing jobless claims in the U.S., which measure unemployed people who have been receiving unemployment benefits for a while (more than a week under UI), fell to 1559K in the week ending 1st January, from 1753K a week before, well below market expectations of 1733K and lowest since June’73 (49-years).

The Pandemic Unemployment Assistant (PUA) initial claims in the U.S., which measure unemployed people, applying for financial help (covers uninsured workers that do not qualify for initial claims under UI), decreased to 0.897K in the week ending 25th December, from 1.554K in the previous week.

 

Overall, as per all types of continuing jobless claims, in January, the NFP job report (Household survey) may show a U.S. unemployment rate of around 3.75% and the number of employed persons (including self-employment/professionals/Home office apart from employment by business firms and governments) may also increase by around 625K.

Fed is already behind the inflation curve. Overall employment and inflation data indicate Fed will launch liftoff and QT from June’22. But if inflation continues to surge at the present pace even in January/Q1CY22, then-Fed may also start the liftoff (gradual rate hikes) in Mar’22 without waiting for another quarter. Fed has to control Bidenflation by Sep’22, just before the Nov’22 election.

As Omicron is more infectious and less hazardous (deadly), it may not impact economic activities/employment significantly as evident from the latest continuing jobless claims. An Omicron-infected vaccinated person will require around 7-days to recover and join work. Still, Fed will wait for any sign for COVID curve plateauing/flattening to make the next policy move. So far Fed is using its strongest tool (jawboning) to control inflation expectations. In reality, Fed is still buying assets under QE but at the same time also trying to manage excess money market liquidity through active reverse repo (backdoor QE tapering/QT). The market is already discounted for three rate hikes in 2022. Now the Fed is preparing the market for a 4th rate hike in 2022 and another four in 2023 with QT from late 2022.

Bottom line:

Powell repeatedly said that Fed is dependent on US core PCE inflation, employment, and also COVID curve. Powell also acknowledged that inflation is already substantially higher than Fed’s target and thus fulfills the rate hike condition. The same is almost true for the maximum employment front.

Now the question is COVID/Omicron curve and whether Fed goes for liftoff in March or June’22 despite it looks parabolic. But going by the experience of South Africa or the even U.K., the Omicron curve is also expected to plateau by January in the U.S., and globally, the two years long pandemic may turn into endemic by June’22 amid huge natural as-well-as artificial vaccinations. This will pave the way for faster normalization by the Fed (3-4 rate hikes in 2022 and the start of QT). Thus Fed may go for liftoff from Mar’22 amid growing media/public/Congressional/White House pressure to act rather than waiting for another quarter (June’22). And Fed may go for QT from July-Sep’22 after two rate hikes in Mar-June’22.

Technically, whatever may be the narrative, USDJPY now has to sustain over 113.90 for any rebound; otherwise, 112.60 may be on the card.

 

 

 

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