An inflection point may have been reached last week. Despite Chair Powell's insistence that the Fed did not adopt an easing bias and
confirmed that there is still no talk of a cut, the market knows better. The
implied yield of December 2024 Fed funds futures contract is about 4.45%, which
is to say, the market is discounting not only the two cuts in the Fed's
September projections, but a third cut, and the risk again (~60%),
of a fourth cut. The first cut is now fully discounted by the end of Q2 24. The
disappointing employment report pushed on an open door, sending US rates and
the greenback lower.
It
fits into the evolving narrative of a dramatic slowing of the US economy after
the heady 4.9% annualized pace in Q3. This is regarded as a forgone conclusion.
It is still early in the data cycle, and the margin of error is large, but the
Atlanta Fed's GDP tracker is seeing 1.2% Q4 GDP, and that was before the
employment report and the roughly 0.25% decline in aggregate hour worked in
October the largest drop in more than two years. That the eurozone and UK are stagnant
or worse, or that despite accommodative monetary and fiscal policy, the
Japanese economy also likely contracted in Q3. is not marginal new information.
The divergence that helped the US dollar recover from the mid-year low may
reverse. And that reversal is because of the developments in the US.
The
dollar's pullback and drop in interest rates will take pressure off the Bank of
Japan and the People's Bank of China. However, the drop in US rates means that
quarterly refunding will take place at high prices, which raises questions of
demand from price-sensitive market segments. Fed officials will begin
explaining themselves, including Chair Powell who is at an IMF-sponsored event
on Thursday. China issues several politically sensitive data points, including
trade, reserves, and inflation, even though the financial markets' response is
usually mild. The Reserve Bank of Australia announces its decision early
Tuesday, and given the Australian's dollar's sharp run-up recently, it looks
vulnerable if there is not hike. At the end of the week ahead, Fitch will
update its assessment of Italy's sovereign debt, which it currently sees as a
BBB credit with a stable outlook. Late last month, S&P affirmed its BBB
rating for Italy. Moody's is to deliver it verdict on November 17, and it has a
negative outlook for its Baa3 (=BBB-) rating.
United
States: In a quiet week after the FOMC meeting and US jobs report, there
are three highlights. First is the new supply of Treasuries at the
quarterly refunding. Many, even if not all observers, link part of run-up in
yields to the increase of supply to fund the deficit. Second, with Q3 GDP
already reported, as was September's advanced merchandise trade balance, the
final September trade figures will be of passing interest. Recall that Q3 GDP
unexpectedly showed a small drag from net exports. The US goods deficit widened
a little in September (to $85.8 bln vs $84.6 bln in August) but year to date
the goods balance has narrowed to about $804 bln from $905 bln in the first
nine months of 2022. The overall trade deficit through August this year is
about $528 bln after a $666 bln shortfall in the same period last year. Growth
differentials and the strong US dollar are expected to be a drag on the
external sector. Third, September consumer credit will be reported. It
unexpectedly declined in August, tumbling $15.6 bln, the most in more than
three years. It was driven by a $27 bln drop in the loans outstanding from the
federal government--primarily student loans. Servicing student loan debt
resumed this month, but ahead it, borrowers repaid nearly $6.5 bln in
September. Despite the elevated delinquency rates, revolving credit (mostly
credit cards) rose by $14.7 bln in August, the largest gain this year. The
median forecast in Bloomberg's survey sees an $11 bln in overall consumer
credit in September. In September 2022, consumer credit rose by $27.6 bln.
The
Dollar Index posted a bearish outside down week, trading on both sides of the
previous week's range and settling below it low (~105.35). We suspect the rally
from the end of July is being "corrected." The next target is
around 104.40 initially, the 38.2% retracement of the rally. The (50%)
retracement is near 103.45, which is around where the 200-day moving average is
found. The Dollar Index gapped lower on November 2. That gap (~105.50-60) looks
technically significant and adds to the bearish technical read.
China: There are
three economic highlights from China in the coming days, trade, reserves, and
prices. A fourth highlight in the form of the monthly lending figures is
possible, as well. It is interesting that in dollar terms, Chinese exports and
imports have fallen by a little more than 6% year-over-year through September.
However, in yuan terms, exports and imports are off less than 1%. In dollar
terms, China's trade surplus has averaged $70.05 bln a month through September.
It averaged $69.95 in the first nine months of 2022. In yuan terms, the trade
surplus averaged CNY489.3 bln in the January-September this year compared with
an average of CNY459.3 bln in the same period last year. Given the sell-off in
bonds and the general strength of the dollar, it would not be surprising if
China's reserves fell for the third consecutive month in October. China's
reserves are the subject of much discussion and interest. Some argue that
China's reserves are greater than officials report and insist on adding the net
currency position of state-owned banks, as if they do not have positions
separate from the PBOC. Reserves are what countries declare. China appears to
have bucketed some of its foreign assets in other pools, less transparent but
not so different than the US. The US
Treasury, for example, says "The foreign exchange assets of SOMA
(Federal Reserve's System Open Market Account) are not US government
assets...", even though it acknowledges that "only the foreign
exchange and SDR components of official reserves are assets of the ESF
[Exchange Stabilization Fund]" and that foreign exchange holdings are
divided between the ESF and the SOMA.
Similarly,
all of China's foreign assets are not its reserves, which are self-declared and
reported to the IMF. Yet, China appears to be bleeding
funds. Portfolio investment is flowing out and retained earnings from
foreign direct investment also appear to be leaving China. Further, consider
the errors and omissions of its balance of payments data. The quarterly average
for the last three years through the middle of this year is about $32.4 bln or
almost $400 bln over the period. This likely reflects capital flight. Lastly,
the third highlight of the week is Chinese inflation, or the lack thereof.
China's CPI disappointed in September, slipping back to 0 from 0.1%
year-over-year. It was -0.3% in July. Still, the nascent and fragile recovery
that is taking hold will likely have helped CPI, though food prices, and pork
play an outsized role. Meanwhile, deflation in producer prices is gradually
ebbing. Producer prices have been falling on a year-over-year basis since
October 2022. The -2.5% in September was the least deflation in six months. The
takeaway is not the precision but the direction.
The
US dollar's retreat will aid the PBOC's effort to slow the yuan's descent.
Indeed, after the disappointing US jobs data, the greenback tumbled to CNY7.26,
its lowest level since mid-September. The fall of a little more than 0.5% was
the most the dollar has fallen in a single session since July 25. With such a
closely managed currency, it is difficult to speak confidently about technical
levels. Still, heavier greenback tone may point to a move toward CNY7.20, and
possibly toward CNY7.10, as short yuan positions are covered. Against the
offshore yuan, the dollar can test the CNH7.26 area and then CNH7.19. If the
offshore yuan trades persistently firmer than the onshore yuan, that also lends
credence to the idea that the near-term trend has changed.
Eurozone: Last week's
preliminary estimate that the region's Q3 GDP contracted by 0.1% takes some
interest from September data. That includes retail sales on November 8. We
already know that Germany retail sales disappointed the median forecast in
Bloomberg's survey for a 0.5% gain. They fell a revised 1.1% in August
(initially -1.2%). France's consumer spending, broader than retail sales rose
by 0.2%, which was half of what was expected, following August's 0.6% decline
(initially -0.5%). Germany reports September factory orders and industrial
output figures. German industrial production fell for four straight months
through August. Factory orders appear to have held in better. They have only
declined tice in the first eight months of the year, but they were large drops:
-10.7% in March and -11.3% in July, which wipes out most of the gains. On
average, through August, German factory orders rose 0.1% a month. Last week,
the preliminary estimate of October CPI showed a softer than expected 2.9%
year-over-year rate. Judging from the base effect, this could be the low print
for the next several months. The results of the ECB's survey of inflation
expectations will be published on November 8. Recall that in August the
one-year outlook was for 3.5% CPI, slightly above the trough of 3.4% in June
and July. It was at 5.0% at the end of last year. The three-year expectation
stood at 2.5% in August. It reached a low of 2.3% in June and was at 3.0% at
the end of last year.
The
euro posted a bullish outside up week. It traded on both sides of the previous
week's range and settled above its high (~$1.0695). The euro reached almost
$1.0750, its best level since mid-September. The US two-year premium over
Germany fell by 20 bp over the last three sessions to its lowest level since
the end of September (~184 bp). The momentum indicators remain constructive,
and the five-day moving average held above the 20-day moving average since
crossing it on October 20. A note of caution comes from the close above the
upper Bollinger Band (~$1.0680). Like several other currency pairs discussed
here, the euro is nearly three standard deviations (~$1.0730) above its 20-day
moving average. If the euro is correcting the slide since the
late July when the high for the year was set near $1.1275, the $1.0765 area is
the (38.2%) retracement objective. Above there, the 200-day moving average
slightly above $1.08. The $1.0860 area is the next retracement (50%).
Japan: A common
question is why the Bank of Japan did not act more forcefully last week when it
downgraded the importance of the 1.0% threshold of the 10-year JGB. Part of the
answer may lie with the data released before the outcome of the central bank
meeting. Industrial output, which was expected to rise by 2.5% edged up by only
0.2%. Retail sales that were forecast to rise by 0.2% fell by 0.1%. The data
reinforced the sense that the Japanese economy contracted in Q3. Recall that it
would have contracted in Q2, but inbound tourism was the crucial offset to the
contraction in consumer spending and business investment. Also, BOJ officials
are not fully convinced that inflation is sustainable. While it did revise up
its inflation forecast for the current fiscal year from 2.5% to 2.8% and the FY
24 (from 1.9% to 2.8%), the forecast for FY 25 remains below 2.0% (from 1.6% to
1.7%). Japan reports September labor earnings and household spending early on
November 7.
Therein
lies part of the problem. Despite what was heralded as a successful spring wage
round, August cash earnings were a mere 0.8% higher than a year ago. Adjusted
for inflation, it is a loss of 2.8%. That translated into a 2.5% decline in
household spending. Japan will also report September's current account surplus,
and it is a surplus. In fact, even though Japan reports a chronic trade
deficit, it runs a persistent current account surplus (think income earned
offshore, such as interest, profits, dividends, royalties, and licensing fees)
that has been 2-4% of GDP for the last eight years. Beyond the macro data, many
still seem to be unclear about the BOJ's intent. It will be watching for
unscheduled bond purchases. Implied volatility of the yen jumped after the BOJ
meeting and if it continues to rise, it could provide the cover for
intervention in the foreign exchange market. That said, one-week and one-month
volatility is well below the levels seen in September-October 2022 intervention
operations. Moreover, the BOJ recognizes that the issue is not just about the
price of dollars (the exchange rate) but also access. To this end, the BOJ
offered to lend dollars against a pool of collateral at 5.58% for a week ending
November 9.
In
reaction to the BOJ's announcement on October 31, the dollar rallied from about
JPY149 to the high for the year slightly above JPY151.70. The greenback has
remained in that range and reached nearly JPY149.20 after the US employment
report. It finished the week below the 20-day moving average (~JPY149.80). The
momentum indicators did not confirm last week's new high, creating a bearish
divergence. On the other hand, while the dollar traded on both sides of the
previous week's range against the yen, the close was (barely) inside the range,
and that neutralizes some of the negative connotations. Still, a close below
JPY149.00 could target JPY148.00-50 initially. A break of that area brings the
October 3 low, seen amid speculation that the BOJ intervened, around JPY147.45.
Australia: The Reserve
Bank of Australia makes its policy announcement early on November 7. The
slightly stronger than expected Q3 CPI (5.4% vs. 5.3% median forecast in
Bloomberg's survey, after 6% in Q2 spooked the market. New RBA Governor Bullock
was cagey about whether it would impact policy. Other recent data, including
September employment data (loss of nearly 40k full-time positions) and
disappointing October PMI warns that the economy is losing momentum. Still, an
IMF staff report encouraged tighter monetary policy and less government
investment to cool inflation. The futures market is discounting a little more
than a 50% chance of a hike, which is almost double the assigned probability
before the CPI report. Prime Minister Albanese visit to China is notable but
the market impact is likely minimal at best.
The
Australian dollar rallied to its best level in two months ahead of the weekend,
amid the broader US dollar pullback and speculation of a possible RBA rate hike
next week. The momentum indicators are trending higher. After six previous attempts
since mid-August, the Aussie managed to close above $0.6500, not simply trade
above it on an intraday basis. Still, it traded nearly three
standard-deviations above its 20-day moving average (~$0.6525) and settled
higher than two standard-deviations (~$0.6470). After matching its longest
advance since January (three weeks) and rising about 2.8% last week (the
largest weekly rally since last November), it looks vulnerable if the RBA does
not lift rates.
UK: The highlight
of the week ahead is the Q3 GDP report. The monthly GDP prints cannot be simply
added up to get the quarterly figure. In Q2, for example, the sum of the
monthly GDP estimates was 0.7% and the quarterly GDP was 0.2%. The UK economy
contracted by 0.6% in July and grew by 0.2% in August. The September GDP and Q3
GDP will be reported at the same time on November 10. After leaving base rate
unchanged at 5.25%, as widely expected, the Bank of England cut its forecast
for Q3 GDP to flat from the 0.4% projection made three months earlier. It
expects a stagnant 2024. In August, it had thought 0.5% growth was likely.
Economists surveyed in Bloomberg's monthly survey expect a flat quarter, not
only in Q3 but in Q4 and Q1 24. The risk seems to be on the downside. Turning
to CPI (November 15), a sharp fall should be anticipated as the 2% surge in
October 2022 drops out of the 12-month comparison. UK CPI will still likely be
the highest in the G7 but closer to 5% (6.7% in September). Although BOE
Governor Bailey says it is too early to begin thinking about a cut in rates,
the swaps market thinks otherwise, and a cut begins to be priced in Q2 24 but
is not fully discounted until late Q3 24.
Despite
the sobering BOE forecasts, and the market bringing forward BOE rate cuts,
sterling had a fine showing. Last week's gain of more than 2% was the largest
advance since last November. The 1.4% raise ahead of the weekend was the
largest since early January, illustrating the impulsive nature of the gains.
Sterling reached $1.2390, its best level since September 20. The close above
the October high (~$1.2335) may give it another cent, or so, near-term
potential, which would see it test the 200-day moving average and meet the
(38.2%) retracement objective of sterling's slide since the year's high was
recorded in mid-July (~$1.3140). Sterling took out the trendline connecting the
two October highs near (~$1.2260). The next technical target may be in the $1.2435-60
area. While the momentum indicators look good, sterling settled above its upper
Bollinger Band (~$1.2330) and approached the three standard-deviation mark
(~$1.2395).
Canada: There is increasing speculation that Canada is slipping
into a recession (two consecutive quarters of economic contraction). The sum of
Canada's monthly GDP prints from February through August has been zero.
Canada's two-year yield peaked near 5% in the second half of September and
early October. It fell below 4.50% last week, a three-month low. As recently as
October 9, the swaps market was pricing in another quarter point hike before
next July. Now it has a cut of the same magnitude fully discounted. Canada
reports the IVEY survey (Monday) and September merchandise trade (Tuesday). The
IVEY survey has been holding up better than the manufacturing PMI (which has
spent the six months through October below the 50 boom/bust level). Meanwhile,
Canada has experienced a deterioration of its trade balance. In the first eight
months of 2022, Canada reported an average goods trade surplus of almost C$2.4
bln. This year, through August, Canada has recorded an average monthly
merchandise trade deficit of C$750 mln.
The
Canadian dollar had its best week in seven months, gaining about 1.50% against
the US dollar. It is not a vote of confidence in Canada's outlook, and the jobs
data were disappointing (loss of full-time jobs and another rise in the
unemployment rate--to 5.7% from 5.5%). Rather, it was more about the US dollar.
The CAD1.3660 area frayed ahead of the weekend, which is also halfway point of
the rally since the end of September. A convincing break of it signals a test
on CAD1.3600 and then CAD1.3500. The momentum indicators are trending lower,
and the greenback is not near its lower Bollinger Band (~CAD1.3535). It settled
before the weekend below its 20-day moving average (the center of the Bollinger
Band) for the first time since late September. Typically, it seems that the
Canadian dollar lags on the crosses in a softer US dollar environment.
Mexico: Mexico's
economy is proving to be more resilient than expected. The October
manufacturing PMI popped back above the 50 boom/bust level (52.1) after dipping
below in September. The IMEF surveys slowed but were still in expansion mode.
Worker remittances were stronger than expected in September. Consider that in
the first nine months of the year, worker remittances have risen by $4 bln from
the same period in 2022 to $47 bln. Meanwhile, despite the peso's appreciation
last year and this year, the trade deficit has fallen to about $10 bln from
more than $25 bln in the first nine months of 2022. Mexican inflation continues
to trend lower on several hours before the central bank meets on November 9,
October's CPI will be reported. It is likely to have fallen for the ninth
consecutive month. The headline and core rates may have fallen around
0.25%-0.40% from 4.45% and 5.76%, respectively. September industrial output is
reported the following day, and the recent slowing trend may remain intact. The
central bank has made it clear that it is on hold, with the overnight rate at
11.25% for a protracted period, which the swaps market says is at least six
more months.
The
peso rose by about 3.8% against the dollar last week (to ~MXN17.2830), the
largest weekly gain since June 2021. It was fueled by dollar's broad pullback,
and we note that among emerging market currencies, the Latam currencies were
the top three (Chile, Mexico, Peru). The carry became more significant,
arguably, with greater confidence that the Fed is done. Risk-on reflected by
strong gains in equity markets also may have contributed. The dollar plunged
through MXN17.75, which is a potential neckline of a double top pattern. Its
measuring objective is near MXN17.00. The five-day moving average drove through
the 20-day moving average for the first time since late September. Ahead of the
weekend, the dollar briefly traded three standard-deviations below the 20-day
moving average, suggesting that from a technical point of view, it is moved too
far too fast. Still, the greenback settled below the lower Bollinger Band
(~MXN17.5570) for the third consecutive session. In a consolidative phase, the
dollar may be able to recover toward MXN17.60-70. A move above the potential
neckline (~MXN17.75) would be disappointing.
Reviewed by Marc Chandler
on
November 04, 2023
Rating:
