Risk aversion was once again the primary theme on Friday, with EURUSD trading down to lows of 1.4660 from a high of 1.4730, while USDJPY traded down to a low of 106.73 from 107.83. Equity markets fell due to concerns over further credit losses among banks, with the S&P500 down by 1.6%, while the S&P financials index in particular fell by 2.5%. US Treasury yields also fell, with 2-years down by 12bp and the 10-years down by 14bp. The FOMC meeting on Wednesday will be the highlight of this week, followed by payrolls on Friday. Our economists forecast a 50bp rate cut from 3.50% to 3.00% and expect the Fed funds rate to be lowered to 2.25% by the end of Q2. With regards to the statement, we expect officials to again emphasize that "appreciable downside risks remain" and that "the Committee expects inflation to moderate in coming quarters." With regards to payrolls, last week's jobless claims confirmed the degree of the weakening seen in the employment report in December. However, our economists have slightly raised their estimate for the rise in nonfarm payrolls to 75k from 50k. It's a heavy data week and other notable releases include durable goods orders on Tuesday, GDP on Wednesday, Chicago PMI on Thursday, and manufacturing ISM and the final reading of the Uni of Michigan consumer sentiment index for January on Friday. We expect the US dollar to strengthen from current levels over a 3-month time horizon, as Fed rate cuts are priced in, we see downside risks to the European outlook and we also expect risk aversion to provide dollar-supportive flows. Ahead today, new home sales for December are due at 1500 GMT.
The focus today will likely be on how the Nikkei 225 trades in light of weakness in US stocks on Friday afternoon. On Saturday, UK newspaper The Times quoted Japan's Financial Services Minister Watanabe as saying that a high-level team was designing the operations of a sovereign wealth fund. The fund would initially invest in local stocks, which would be yen-supportive, but it is unknown at this stage how large the fund would be. It is difficult to envision the authorities announcing an allocation shift that would be large enough to drive speculation on further yen strength. On Friday, Japan's core consumer prices rose at their highest y/y pace in a decade in December, driven by rising energy and food prices. However, OIS markets are still pricing in 13bp of cumulative rate cuts over the next 12 months, reflecting market concerns about the impact of likely waning global demand on Japan's economy. Governor Fukui also pledged on Friday to keep monetary conditions accommodative considering the slowing economy. This week, the December jobless rate is due on Tuesday and industrial production on Wednesday. We see USDJPY remaining in a 105-110 range, and our underlying bias is for a test of the 105 boundary.
At 109 (cons. 109, previous: 109) French business confidence remained flat, while last month's result was revised down from 110 to 109. In Germany consumer confidence came in better than expected (last: 4.5, cons. 4.4, previous. 4.5). Our economists note that business confidence in the Eurozone was recently more resilient than generally expected, with the last ZEW survey results the single exception. In contrast, seasonally-adjusted Italian retail sales fell 0.3% m/m, the weakest result since April 2007. In other news, ECB's Liikanen highlighted today that the central bank has to stop second round effects from high commodity prices, and that next few months are significant in gauging the impact of a US slowdown on the Eurozone.
Canada's December CPI report, released Friday, showed relatively tame numbers. Headline CPI of 2.4% was in line with expectations while core CPI dipped to 1.5% from 1.6%, previously, below the expected 1.7%. With this month's tamer than expected core CPI tracking comfortably below the mid-point of the Bank of Canada's 1-3% target range, our economists expect the central bank will continue to lower the overnight rate target, cutting by another 25bp to 3.75% at the next meeting on March 4. It is a relatively light data week in Canada. GDP growth for November, due Thursday, is expected to be stable at 0.2% m/m. Our USDCAD one- and three-month forecast is 1.05.
In the holiday-shortened week in Australia, business confidence, due Tuesday, is important after easing below trend recently. Credit, out Thursday, could rise again due to business lending. A well respected journalist argued in the press that the RBA could deliver an additional two rate hikes in the coming months. Our economists are forecasting one more rate hike at the February meeting. Equity sentiment has rebounded in the sessions following the Fed's inter-meeting 75bp rate cut. Arguably, the AUD will be supported from rate differentials heading into the February RBA meeting. However, our global economics team have downgraded their global economic forecasts and the new Australian government is planning aggressive spending cuts. Hence, from an asset allocation perspective we remain negative on AUD. There may be opportunities for tactical longs in the near-term, but this would strictly be a short-term trade. The bigger moves in AUD are likely to be to the downside.
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