Week Ahead: Little to Stop the Surging Dollar

The dollar's Q4 rally continued last week. The Dollar Index has risen in the first eight weeks of the fourth quarter, gaining a little more than 7%. Half of the G10 currencies (the euro, the Swedish krona, the Norwegian and Danish krone, and New Zealand dollar) fell to new lows for the year last week. Part of the story is the paring of Fed cut speculation. The derivatives market no longer has even 50 bp of cut discounted between now and the middle of next year. The effective Fed funds rate at the end next year is seen near 3.90%. It was below 3% at the end of September. At the same time, developments in Europe and Japan have not been inspiring. The German government is broken, and vote of confidence next month will pave the way for elections in early in 2025. The French government will likely invoke a constitutional power that allows it to bypass parliament to adopt the budget. However, this will trigger a confidence vote that the government is unlikely win. Japan has its first minority government, and it reenforces the traditional bias of providing ever more fiscal support. At the same time, geopolitics tensions have risen in Europe and Russia has stepped its refined uranium export restrictions and China is poised to do the same at the start of next month for some rare earth exports. 

The divergence between the US economic performance and most of the other high-income countries is stark and this is even before the next administration's tariffs, tax cuts, and de-regulation. In the coming days, the US, the eurozone, Japan and Australia report inflation. For the US, the October PCE deflator will confirm the small increase already reported by the CPI (and key PPI components). The eurozone's flash October CPI is expected to have increased for the second consecutive month. Still, the market is discounting around a 50% chance that it delivers a half-point cut next month. Japan's Tokyo CPI is reported weeks ahead of the national figure and offers a robust signal. After re-visiting the low for the year of 1.8% in October, Tokyo's CPI is likely to have rebounded in November to 2.2%-2.3%. The swaps market has 15 bp of tightening discounted for the BOJ next month. The BOJ hiked its overnight rate by 15 bp in July after a 20 bp hike in March. Australia's October CPI likely ticked up for the first time since May. The RBA is not seen cutting rates before Q2 25, but the Reserve Bank of New Zealand is expected to deliver its second consecutive half-point cut on November 27. The move will bring the cash rate target to 4.25%. 

 

United States:  Investors (and policymakers are the world) are trying to work out the implications of the broad Republican victory in national elections and a second Trump term. It is still not evident what is a negotiating position, a principled position, and campaign rhetoric. There is also the question of how others respond. It appears, for example, that Russia and China are exploring some export restrictions. More immediately for businesses and investors is the outlook for next month's FOMC meeting. The Federal Reserve Chair who seemed to have maneuvered his colleagues into initiating the easing cycle with a 50 bp cut in September, said at the recent press conference and again last week that given the resilience of the economy, there is no sense of urgency. Pricing in the Fed funds futures market is consistent with slightly less than a 60% chance of a quarter-point rate cut on December 18, which is down from around 80% in the before the election. The FOMC minutes will be helpful in assessing where the bar is in the data-dependent mode. One would think that the PCE deflator, which the Fed targets, would be an important data point but the CPI and PPI have already given the signal. And that signal is one of slightly firmer price pressures. The headline deflator is expected to rise by 0.2% for a 2.3% year-over-year (from 2.1% in September), while the core rate may rise by 0.3% for a 2.8% year-over-year rate (from 2.7% in September. The 0.2% rise in the headline would keep the 3-month annualized rate at 2.0%. The 0.3% rise in the core rate would lift the three-month annualized rate to around 2.8%, depending on the rounding from about 2.4% previously. Chair Powell has indicated that 1) the Fed expectations a bumpy path back to the inflation target and 2) it will take more than a couple of monthly prints to persuade it otherwise. Meanwhile, consumption expenditures (expected to rise by 0.4% after 0.5% in September) and durable goods orders (expected to rise by 0.4% after falling 0.7% in September) point to 2.0%-2.5% Q4 GDP. 

The contrast between the US economic performance and Europe and Japan struggles was reflected in the preliminary November PMI that were released before the weekend. It sent the Dollar Index to new two-year highs, a little above 108.00. It had peaked during the Truss/Gilt crisis in September 2022 a little above 114.75. Last week it surpassed the (50%) retracement of the subsequent decline. The (61.8%) retracement is almost 109.00. Support now is seen around 107.00. 

Eurozone: The market is convinced that the ECB cut rates again at next month's meeting. In fact, after the disappointing flash PMI estimate, the swaps market moved to price about a 50% chance of a half-point cut next month, up from less than a 25% chance a week ago. Between now and mid-2025, slightly more than 135 bp of cuts are discounted. This week's preliminary November CPI may temper the speculation. The challenge is that in November 2023, the eurozone's CPI fell by 0.6%. That makes for a difficult comparison. A 0.2% decline translates to a flat three-month annualized rate but would mean that year-over-year rate in November would rise toward around 2.4%. It would be the first back-to-back increase in the year-over-year headline rate since September-October 2022. 

The euro was kicked lower after the poor PMI and in thin trading between late Asian turnover and the European morning before the weekend. It tumbled from nearly $1.05 to $1.0335. This is a fresh two-year low. It managed to bounce a cent before consolidating around $1.04. The cyclical low was seen in late September 2022 near $0.9535. Last week was the third consecutive week that the euro fell by more than 1%. Since the end of Q3, it has only advanced in one week. It finished Q3 near $1.1135. The US two-year premium over German recovery began a week before the euro's descent. It has now risen by 100 bp since the Autumn Equinox to 235 bp. 

Japan: Tokyo's CPI provides similar insight into national inflation, as the preliminary eurozone CPI anticipates the final reading, and the US CPI/PPI takes much of the guesswork out of the PCE deflator. Tokyo's October CPI was 1.8% at the headline, core, and ex-fresh food and energy levels, which matches the year's low. It has not been lower since March 2022. The same is true of the core rate. Japan's national CPI runs a little hotter with a 2.3% headline rate and 2.2% core rate in October. The BOJ is determined to normalize monetary policy, and a soft inflation print will not be a formidable obstacle. Nor is the faint growth. Every year since 2005, with the exception of 2017, Japan has experienced at least one quarter on contracting growth. This year it was Q1 (-0.6%). The economy expanded by 0.5% in Q2 and 0.2% in Q3. The prospects for growth are slightly better in Q4. This week's October employment, retail sales, industrial production, and housing starts will test that hypothesis. 

The dollar has risen in every week but one here in Q4 against the Japanese yen. It settled Q3 near JPY143.65 and reached JPY156.75 in mid-November. The greenback mostly consolidated last week between roughly JPY153.30 and JPY155.90. It found support near the 20-day moving average (~JPY153.85). The dollar last closed below the 20-day moving average in late September. The momentum indicators have been slipping, but it may take a deeper pullback in US rates and a break of JPY152 to signify anything important. 

Australia: The Reserve Bank of Australia was later than most G10 central banks to tighten policy and it tightened less than most. Now, it is one of the most hawkish central banks. It took the RBA some time, but it did persuade the market that there will not be a cut this year. Indeed, the futures market does not have the first cut fully discounted until next July (though there is more than a 90% chance of a cut in May). Australia reports its monthly October CPI on November 27. The headline and trimmed mean measures have fallen for the past four months to 2.1% and 3.2%, respectively. The risk is that both measures increased last month. Officials put more weight into the quarterly measure, which was at 2.8% in Q3 (3.8% in Q2), and the underlying measures averaged 3.65% (vs.4.1% in Q2). Meanwhile, the Reserve Bank of New Zealand is widely expected to deliver its second consecutive 50 bp rate cut on November 27. It would bring the cash target rate to 4.25% from 5.50% as recently as July. The swaps market sees another 100 bp of cuts next year. 

The Australian dollar resisted the greenback's surge and rose by about 0.70% last week. The price action before the weekend was mildly encouraging, and the momentum indicators have turned higher. The Aussie recovered from a four-day low near $0.6470 to resurface above $0.6500, which served to keep the consolidative tone intact. It had recorded a three-and-a-half month low near the middle of the month (~$0.6440). The Australian dollar's bounce in the first part of last week (~$0.6545) met the (38.2%) retracement objective of the losses since the FOMC meeting. The next retracement target and the 20-day moving average are found in the $0.6550-$0.6565 area. The New Zealand dollar was sold to new lows for the year before the weekend, slightly below $0.5825. Last year's low was near $0.5775, and that is the next obvious target. The 2020 pandemic low and the low from October 2022 were near $0.5500. 

China: The November PMI will be released on Saturday, November 30. It will be disappointing if there is not continued improvement in the composite. Recall that it was firm in Q1, rising from 50.3 in December 2023 to 52.7 in March, which is the high for the year. It fell through August to reach 50.1. Stimulus measures were announced in September and the composite PMI firmed in September and October to 50.8. The manufacturing PMI has been below 50 for most of the year but was at 50.1 in October. The non-manufacturing PMI has not been below 50 since the end of 2022 but reached it in September before ticking up to 50.2 in October. 

The PBOC has been setting the dollar's reference rate considerably lower than expected, which serves the purpose of slowing its appreciation. Still, it is allowing a gradual move. The dollar has risen against the offshore yuan for the past four sessions and in nine of the past 11. It was the sixth consecutive week that the greenback advanced. It traded slightly above CNH7.2670 ahead of the weekend, its best level since late July. The dollar peaked in early July above CNH7.31 and looks headed back toward it. The greenback has risen for eight consecutive weeks against the onshore yuan, the longest rally since 2018. It is bumping up against CNY7.25 and has not traded above there since the end of July. 

United Kingdom: British economic data is surprising on the downside. The point was underscored ahead of the weekend with the flash composite PMI falling back below the 50 boom/bust level and October retail sales falling twice as much as expected, with September revised lower. Still, on the heels of a firmer CPI reading, the BOE seen standing pat next month. There is about an 85% chance of a cut at the first meeting in 2025 (February 6). The UK's economic diary is light in the coming days, featuring consumer credit and mortgage data. Along with the BRC shop price index and the CBI retail report, they typically do not move the markets. 

Sterling, which had been above $1.30 when the US voted, fell below $1.25 at the end of last week for the first time in a little more than six months. It is the eighth consecutive weekly decline. It matches the longest losing streak since 1973. The $1.26 area may now act as a cap. The low for the year was set April 22 near $1.2300. 

Canada: September and Q3 GDP are released at the end of the week. After stagnating in August, the economy is expected to have grown by about 0.3% in September. If true, it would be the best monthly performance since April. For the quarter, which means something on around 1.3% at an annualized pace, down from 2.1% in Q2. This coupled with the uptick October CPI and continued depreciation of the Canadian dollar may discourage speculation of another half-point cut when the Bank of Canada meets on December 11. 

The Canadian dollar was the strongest G10 currency last week, rising by about 0.7% against the US dollar. The only other G10 currency to have risen against the greenback last week was the Australian dollar, which rose by about 0.5%. The US two-year premium over Canada narrowed for six consecutive sessions through the end of last week, and near 95 bp is the least in more than a month. Still, the Loonie is not out of the woods, yet. The greenback found support near CAD1.3930, which is the (61.8%) retracement of the post-election rally. A move above CAD1.4020 could signal a retest on CAD1.4100. 

Mexico: Mexico recorded a $2.8 bln trade deficit in Q2 24 but $3.6 bln current account surplus. The trade deficit swell to $5.5 bln in Q3. Mexico reports Q3 current account balance on Monday and the October trade figures on Wednesday. Mexico's trade with China is coming under closer scrutiny and Canada's Prime Minister Trudeau brought it up at the recent APEC summit. Mexico imported a little more than $120 bln of goods from China last year. China is Mexico's second large trading partner after the US and Mexico imported more than twice as much from the US as it did from China. Mexico imported $14 bln from Canada. Reports suggest that one in three cars sold in Mexico this year will be built in China. This is up from 4% in 2020. Meanwhile, the constitutional reform" the gets rid of several oversight bodies, including transparency, anti-trust, telecom, energy education, and social policies has made its way through the lower chamber of the legislative branch. The functions will be reassigned to ministries. Lastly, Mexico's consumer prices moderating further in the first half of November, and this suggests Banxico can deliver another rate cut when it meets on December 19, the day after the FOMC meeting concludes. 

The dollar reached a six-day high against the Mexican peso at the end of last week, slightly above MXN20.55. The previous week's high was near MXN20.70, and the post-election was closer to MXN20.8070. Between the different treatment toward China, the refugee issue, and the Trump administration is favors onshoring over near-shoring, and the less than investor-friendly policies in Mexico, which is gradually seeing its high-yield status diminish casts a pall over the Mexican peso. A push toward MXN21.00 in the coming weeks seems a reasonable target. 

Disclaimer