Weak US economic data brought a setback to the soft landing narrative and start-of-the-year risk rally. US retail sales fell by more than expected (-1.1% m/m) in December, while industrial production declined 0.7% m/m, supporting the view that the US economy is losing further momentum. Risk sentiment soured and yield curves flattened from the long end, despite comments from Fed officials that stressed more rate hikes are needed.
In contrast, the euro optimism got another boost after German ZEW expectations showed a larger than expected rebound in January, turning positive for the first time since Russia’s invasion of Ukraine. The German economy has been holding up better than feared and leading indicators suggest that the European recession could actually be milder and shorter than we have previously anticipated. That said, until the energy crisis is truly resolved, Germany is unlikely to return as the euro area’s economic powerhouse anytime soon.
An ‘ECB sources’ news story further added to the European fixed income rally, reporting that policymakers are starting to consider a slower pace of rate hikes than President Lagarde indicated in December. While the 50bp hike she signalled for February remains likely, the prospect of a smaller 25bp increase at the following meeting in March is gaining support according to officials. Implied ECB peak rate pricing edged down to 3.3%, but we stick to our call of 50bp hikes in both February and March and only expect ECB to slow the hiking pace to 25bp in May amid still high core inflation pressures.
Bank of Japan kept monetary policy unchanged at its meeting this week. The market had speculated another hike of the cap over 10Y yields could come and was left disappointed, which triggered a rally in USD/JPY above 131. We stick to our view that a policy rate hike to 0% and another hike in the yield curve control target awaits in Q2 23.
The Chinese economy performed better than expected in Q4 22 (0.0% q/q versus our and consensus expectations of a decline of -1.0% q/q), leaving annual growth for 2022 at 2.9%. Data also suggests that Q1 23 could be stronger than expected, as Covid cases have already peaked in the big cities and we now look for an even more frontloaded recovery starting already in early Q1 (see China growth update – More frontloaded recovery, 18 January). That said, longer term the Chinese economy faces some of the same challenges as most western economies, with the population declining in 2022 for the first time in 60 years.
UK inflation eased 0.2pp to 10.5% in December, but with core inflation remaining unchanged at 6.3% and wage growth edging even higher (+0.2pp to 6.4% in November), pressure is rising for Bank of England to deliver another 25bp rate hike not only in February, but also in March.
The macro highlight next week will be the January PMI figures on Tuesday. It will be interesting to see whether the rebound in euro area leading indicators extends into Q1 23. In the US, we expect PMIs still to paint a weak overall picture, as it seems the economy clearly lost steam in December and we look 2.8% q/q AR in the Q4 22 GDP figures released on Thursday.