Dollar Narrowly Mixed as Fed Awaited

(from my colleagues Dr. Win Thin and Ilan Solot)

The dollar is mixed against the majors. The euro and pound were little changed, at $1.2730 and $1.6130. The dollar is outperforming against the Scandies, especially the Norwegian krone, but it is flat against the yen at ¥108.10. The Canadian dollar and Australian dollar are outperforming on the day. In the EM space, Brazil closed 2.5% stronger yesterday, while most EM currencies are trading today with a stronger tone, notably TRY and IDR. On the other side of spectrum, RUB continues to underperform. The MSCI Asia Pacific index gained 1.3%, while EuroStoxx is up about 0.5% near midday. US equity futures are pointing to a lower open. Oil futures are up about 0.5% on the day.

Although there had been some jitters, investors have come around and expect the Federal Reserve to announce its commitment to end QE today. We expect the statement to reflect that the centrist core (Yellen, Dudley, Fischer)remains in control. That means the continued use to three cues: the "significant under-utilization" of the labor market, the "considerable" period between the end of QE and the first hike, and that the Fed funds rate may remain below what is regarded as the long-term equilibrium level.

Perhaps the most interesting part of the statement may be how the Fed addresses the decline in market-based measures of inflation expectations. This part has potential to surprise investors. If the topic is played down, or not even addressed, investors may feel more confident of a rate hike in the middle of next year, as Dudley, and others, have indicated is a reasonable scenario. To the extent that the Fed expresses concern, it may encourage investors to continue to push out the first hike.

France and Italy agreed to tighter fiscal measures. This means that the European Commission will not be sending back the budgets for review. Earlier this week, France agreed to cut its budget deficit next year by an additional €3.6bn. Meanwhile, Italy will use €3.3bn in a fund originally set aside for tax cuts to reduce its deficit. This is a positive development, but it’s likely to be just a temporary truce. This story will come back to haunt us for sure. Given the feeble economic state of most EU countries, budgetary frictions will remain a constant source of friction for the foreseeable future.

In line with our long held view, evidence continues to mount that there is very little chance of the BOE hiking rates until next year. The latest dovish voice was from Deputy Governor Cunliffe arguing that emergency stimulus should be kept for longer. The Deputy Governor mentioned “The softening in the pay and inflation data, together with the weaker external environment,” as reasons for why the scope of tightening monetary policy has been reduced. Yields in short-sterling futures are down slightly and the pound stable after the comments.

Eurozone data was on the weak side. French consumer confidence for October came in at 85 vs. 86 consensus. Seasonally adjusted retail sales in Spain disappointed, rising by only 1.1% y/y in September vs. 1.9% expected. In Japan, however, September IP numbers surprised on the upside at 2.7% m/m vs. 2.2% expected, and the highest since January. The y/y figure unexpectedly turned positive again, after contracting for two months. This comes after firmer than expected September retail sales were reported yesterday in Japan.

Today is Norway’s turn in the spotlight. NOK is underperforming after weaker than expected unemployment (3.7% in August vs. 3.5% consensus) and retail sales (-0.1% m/m in September vs. 0.7% consensus) were reported. After the Riksbank cut yesterday, markets are likely sensitive now to a potential move by the Norges Bank. Norway is not struggling with deflation (headline CPI rose 2.1% y/y in September) nor with recession, but headwinds to growth may be building. Rates have been at 1.5% since the last 25 bp cut in March 2012. EUR/NOK is likely to soon test the 8.5 area.

Brazilian central bank meets and is expected to keep rates steady at 11.0%. Market consensus for end-2015 SELIC fell to 11.5% from 11.875% last week. While pipeline pressures have eased, inflation at the consumer level remains high. September tax collections will also be reported, seen rising 8% y/y. Market is looking for poor September budget data on Friday. Brazil assets have gained some traction after the initial post-election selloff, however, with USD/BRL moving back below 2.50. Support is seen near 2.45 and then 2.40.

Chile reports September manufacturing output and retail sales. The former is expected to rise 0.9% y/y, while the latter is expected to rise 1.8% y/y. The economy remains weak, but with inflation at cycle highs and well above the 2-4% target range, the central bank has signaled a pause in the easing cycle after the last 25 bp cut to 3.0% in October. Stabilizing copper prices have allowed the peso to gain some traction. For USD/CLP, support is seen near 570, resistance is seen near 590.