The wait for US inflation continues
The start 2018 should bring reassuring news for traditional economists as the strong US economy, with minimal slack will start producing steady inflation. Markets expect a strong rebound of US December core CPI of 0.3% m/m following a weak reading of 0.12% in the previous month. Strong monthly read will push up annual read to 1.8% from 1.7% in November. Higher food price should offset decline in energy prices in December (but likely reverse due to adverse weather conditions in Jan). Sharp fall in retail gasoline prices are likely offset by rise in expenditures to heat homes like natural gas, heating oil and electricity prices. We expect December headlines CPI to increased .18% m/m and 2.1% y/y. The overall effect should be supportive of the Fed hawk views that three 25bp hikes are appropriate for 2018.
A marginal USD rally should be anticipated as the Fed fund pricing increase probability in March, June and September, Yet taking a broader view we suspect that trend of inflation will underwhelm the majority of FOMC member likely resulting in the removal of the June rate hike. Disappointing wage growth reported in recent payroll report suggests that wage growth remains subdued despite tighter labor market. On a side note retail jobs create fell suggesting that reports of new online economy replacing old brick in mortar (which is in rapid decline) might be over estimated. Remaining slack in low skill market is another reason why PCE is unlikely to accelerate. Our longer-term view for USD remains bearish against higher yielding EM currencies.
EUR/USD heading higher in 2018?
Looking back at yesterday’s currency exchange moves, we might be asking ourselves whether the EUR/USD pair may be turning differently to what analysts might be considering for the coming period. As such, we’ve been witnessing the slow decrease from January 4th (EUR/USD at 1.2067) up to January 8th, where we’ve reached below 1.20 to end up at 1.1924 yesterday. Similarly, the EUR weakened against the JPY (-0.82%) but remained stable compared to other peers.
Multiple reasons could explain the phenomenon: 1) investors were waiting for German negotiation for a potential coalition between the Union party (CSU/CDU) and the Social Democratic Party (SPD) that appears to have found a compromise as early as yesterday during an agreement with regard to an immigration law that relies on attracting new skilled labor force; 2) Investors might be thinking that the EUR is becoming too strong, impeding EU exportation competitiveness, thus reducing growth perspectives; 3) Investors are looking for the ECB Monetary Policy Meeting taking place on Thursday (which we are confident will not tighten, though economic conditions increasingly improve, as demonstrated by the yesterday’s November EU jobless claim report that falls to its lowest rate in almost nine years, at 8.70%).
Due to strong expected IP growth for November data in Europe (France and UK), we are looking forward to see how the FX market will react. However, over the mid-term period, we remain confident that the market should expect a EUR/USD pair turning around 1.18 for 1Q 18 that slowly reaches the 1.20 in 2Q 18. Keeping in mind the fact that the EUR/USD PPP amounts to 1.33 according to the OECD, we still maintain our opinion that the EUR remains somewhat undervalued within the longer-term.
