A range of crosscurrents from geopolitical risks, policy uncertainty and fears over Fed independence continued a noisy start to the year. US bank earnings were mixed but the key driver of sector weakness was proposed caps on credit card interest rates, while ongoing valuation concerns weighed on US equity markets. In the FX space, likely snap elections in Japan are driving a weaker Yen on the view that an increased majority for the governing LDP could lead to more supportive fiscal and monetary settings. At around 158 USDJPY is pressing highs since 2024, fueling speculation over possible currency intervention.
Expectations for two Fed rate cuts remained intact this week, priced for June and September. Fears of renewed inflationary pressures were allayed as US CPI remained steady in November, matching consensus at 2.7%yr on a headline basis while core inflation held at 2.6%yr against an expected lift to 2.7%. Those rates were slightly below producer price inflation that rose to 3%yr in headline and core terms, above the 2.7% consensus for both measures.
Putting all this together, estimates are for the core PCE deflator - the gauge the Fed sets policy to - to be in the order of 3%yr, which is still elevated to the 2% target but expected by the Fed to decline as the year progresses. The clear risk to that view is if firms look to pass through more of the tariff-driven increases to their input costs to the consumer, but so far firms are using profit margins to absorb a good degree of those higher prices. On the consumer, November retail sales that aligned with Black Friday were solid rising by an above-consensus 0.6% month-on-month while the control group lifted 0.4% month-on-month.
Money markets in the UK continue to price a further two cuts from the Bank of England this year. Positions in UK assets come up against event risk next week with the December inflation report due. Despite a soft start to the year, Sterling is up around 1.6% against the USD as markets removed the risk premium built in during the run up to the Autumn budget. Strong inflation data could see that momentum continue if BoE easing bets are pared back. Meanwhile, pricing has been unchanged so far in 2026 for the ECB to remain on hold through the year.
Pessimism around the economic outlook and finances in the year ahead may pose risks to the acceleration in spending by Australian household seen in late 2025 continuing. Black Friday sales and major events drove household spending to a 1% month-on-month rise in November (see here), adding to the 1.4% surge in October - its fastest gain since early 2024. Strong momentum in discretionary spending has been the key, a sign that lower inflation and RBA rate cuts help to free up households to spend at the sales and as the major sporting events (NRL and AFL finals and Spring racing carnival) and concerts came around.
Since then, the RBA at its December meeting indicated further cuts were unlikely with upside risks to inflation increasing. Although markets price potential RBA tightening as a story for the second half of the year, households may be wary. Consumer sentiment declined by 1.7% in January according to the Westpac-Melbourne Institute Index as views around the outlook for household finances (-4.5%) and economic conditions (-6.5%) deteriorated. That said, the index has fallen in four of the past five months, with spending still accelerating through October-November. December's labour force report is due next week where a slight uptick in the unemployment rate to 4.4% is expected. Job vacancies this week were consistent with a steady labour market as vacancy levels were broadly flat over the reporting period to November (-0.2%).
