The week ahead is important from a macro
perspective. The data highlights include China's PMI, eurozone preliminary
October CPI and Q3 GDP, and the US (and Canadian) employment reports. In
addition, the Federal Reserve meeting on November 2 is sandwiched between the
Reserve Bank of Australia meeting and the Bank of England meeting.
Let us preview
the data before turning to the central banks. Yet the
challenge with the data is that the underlying macro views are unlikely to
change. Central banks say that policy will be data-driven, but it begs the
question of what data and how it fits with the forward guidance.
This seems to
be less the case in China. The October PMI will be reported
before the markets open on Monday. The US, eurozone, and UK preliminary October
PMIs were below the 50 boom/bust level, yet the ECB hiked last week, and the
Fed and BOE will hike in the coming days. China's composite PMI was at 50.9 in
September. The unpredictable Covid-related restrictions continue to plague the
economy, which also suffers from weak consumption and the collapse of the
property sector. The US latest sanctions in the semiconductor industry are a
significant escalation of US efforts to contain China's development. The full
ramifications will take some time to sort out, but this is important.
The eurozone
reports its preliminary October CPI figures and its first estimate of Q3 GDP. The euro was
little changed to slightly firmer in October. Energy was mixed. Brent oil
snapped a four-month drop and gained about 9.4% in October. The Dutch benchmark
for natural gas fell around a third. While that sounds helpful, these are
wholesale prices, not retail. National harmonized figures from Germany, France,
Italy, and Spain surprised on the upside. After a 1.2% surge in eurozone
September CPI, a 0.7%-0.9% rise in the aggregate measure is likely and it will
keep the year-over-year rate around 10%. The core rate may prove sticker.
It may have reached a new cyclical high, approaching 5%.
With some
national figures released before the weekend, it now looks as if the eurozone's
economy may have expanded by 0.1%-0.2%. At best, it
looks like a transition quarter between the expansion and the coming
contraction. Most economists see the contraction beginning in Q4 and carrying
into next year. It is clear, though, that a mild recession is not going to
prevent the ECB from normalizing monetary policy. Last week's 75 bp hike lifted
the deposit rate to 1.50%. The market envisions at least a 50 bp increase at
the mid-December meeting and a terminal rate of about 2.75%.
As of the
middle of October, the ECB's balance sheet stood at nearly 8.8 trillion euros. During the
Great Financial Crisis and the pandemic, bond purchases were the common
way central banks expanded their balance sheets. However, about a quarter of
the ECB's balance sheet is accounted for by loans. A little more than half of
those loans (1.2 trillion euros) are due in the middle of next year. The
changes the ECB announced last week will likely encourage early repayments.
Therefore, in addition to the interest rate hikes, even if the ECB carries on
recycling the maturing proceeds of its holdings, its balance sheet is poised to
fall sharply around the time it reaches what is now expected to be the terminal
rate.
The end of the
week features the October US employment report. Job growth is
gradually slowing. The median forecast is for the private sector may have
filled slightly less than 200k jobs. That would be the least of the year and
bring the three-month average below 300k. Still, it needs some context.
Consider that in 2018-2019, the private sector added, on average, about 150k
jobs a month. The participation rate had bounced between 62.1% to 62.4% this
year compared with 63.3%-63.4% in the three months before Covid struck. At the
same time, the unemployment rate has been between 3.5% and 3.7% since the
3.8%-4.0% readings in January and February.
Hourly
earnings are expected to have risen by 0.3% for the third consecutive month in
October. In October 2021, average hourly earnings rose by 0.6%. The base
effect would see the year-over-year rate slow below 5% for the first time since
September 2021. Looking ahead, the base effect will make favorable comparisons
over the next three months. This dovetails nicely into ideas that the Fed will
moderate the pace of hikes after this week's three-quarter-point move.
Which is a
nice segue from the market-sensitive macro data to the central bank meetings. The key issue
for the markets is not about the fourth consecutive 75 bp hike, which puts the
upper end of the target range at 4.0%. That is as done of a deal as these
things get. Rather, it is about the Fed's signal of its intentions. The market
sees a terminal rate near 5.0%. The futures market has about a 50% chance of
another 75 bp hike in December, but the conviction seems soft as the idea of calibrating
the pace has apparently gained momentum. Of course, it is data dependent, a
mantra that has been repeated enough times that it is devoid of much substance.
Given the base
effect, the lagged impact of the tightening of financial conditions, dollar
strength, and recent price trends, CPI, the key data point, is likely to slow
markedly in the coming quarters, beginning this month. This will
provide a favorable backdrop for slowing the tightening pace. Moreover, despite
concerns expressed by Treasury Secretary Yellen about bond market liquidity,
the Fed will most likely reaffirm the current effort to unwind the balance
sheet ($95 bln a month). That said, many observers do not think the Fed is yet
on a sustainable course. Some banks are already warning that the balance sheet
roll-off will end toward the middle of next year as the system needs more
reserves, while others, like Harald Malmgren, a senior White House adviser from
Kennedy through Ford, see the Fed eschewing the 2% inflation target and adopting
a 3%-4% target.
There have
been six FOMC meetings this year. The Dollar Index rose on the day of
the first (January 26), and the last (September 21), while falling on the other
four. But if there is a meaningful pattern, it is as obvious as it may seem. Sometimes
the dollar rallied the day before and sometimes the day after. And two out of
six is still close enough to 50/50 as not to be a solid basis for a trading
strategy. Also, the two-year note yield has risen on three of the meeting days
and fallen on the other three.
The Reserve
Bank of Australia's decision will be announced early on November 1. Even though
CPI accelerated more than expected in Q3 (7.3% vs. 6.1% in Q2), the market is
still comfortable with a quarter-point hike. Recall that the RBA began its
normalization cycle in May with a 25 bp hike. It then proceeded to deliver four
half-point moves through September. Finally, it slowed the pace back to 25 bp
in October, lifting the cash target rate to 2.60%. The futures market sees the
RBA hiking through most of the first half of next year with a terminal rate
near 4%.
Without being
too concerned about the precise definition, Australia is seen to be the least
likely, according to Bloomberg surveys, to fall into a recession over the next
12 months. The median result saw a 25% chance. That is half the odds for its
neighbor New Zealand and a little less than the 30% chance of a recession in
Japan. The risk of a recession in the US is put at 60%, 80% in the UK, and 90%
in Germany. The risk of a recession in France is the same as in the US. Canada
is among the lowest at 45%.
The Bank of
England meets on November 3, the day after the FOMC meeting concludes. In a savvy
move, Prime Minister Sunak delayed the fiscal statement that was scheduled for
October 31 to November 17. This will allow the Office for Budget Responsibility
to consider the sharp drop in UK interest rates over the past couple of weeks
that unwound most of the spike. Some estimates suggest that using the updated
rates could reduce the funding gap by as much as GBP15 bln.
Even though
the details of the fiscal program will not be announced before the BOE meeting,
the unambiguous signal is for an austere budget, the opposite of Truss's
spending and tax cuts. Amid the market turmoil in late September
and threats by the Bank of England for drastic action, the swaps market
discounted a 150 bp hike. However, as the unfunded fiscal stimulus was
retracted and financial orthodoxy took hold, the market has scaled back
expectations. The swap market settled last week with roughly split
between a 50 bp and 75 bp move. A three-quarters point move would lift
the base rate to 3.0%. The swaps market sees the peak coming in Q2 23 near
4.75% in Q2 23.
The UK's
two-year yield was around 3% before the market chaos. It reached
nearly 4.75% in late September and fell to about 3.10% last week before
bouncing into the weekend. The long end of the curve, where BOE's bond-buying
efforts focused on stabilizing the market, had seen the 30-year yield rise
above 5% on October 12. Last week, the yield slipped to 3.45%. It also
recovered a head of the weekend. 3.60%. It was near 3.50% in
mid-September. For its part, sterling has also recovered smartly. It had fallen
to $1.0350 (according to Bloomberg) in late September, a record low, and pushed
to almost $1.1650 last week. It found support near $1.1500 ahead of the
weekend, amid a broad dollar recovery. The euro spiked above GBP0.9250 in
the late September chaos, but by the end of the week, it had returned to the
GBP0.8600 area, where it was before the turmoil.
Let us turn to
the individual currency pairs.
Dollar
Index: The five-session pullback ended on October 27, helped by a
dovish read of the ECB. However, even after the higher-than-expected
inflation readings by Germany, France, and Italy, and the dramatic rise in
rates, the Dollar Index extend its recovery ahead of the weekend. We
envisioned that after the ECB and BOJ meetings, the focus would shift back to
the US ahead of the FOMC meeting and the employment data. This would
allow the Dollar Index to extend its recovery. The MACD looks poised to
turn higher, while the Slow Stochastic has a little bit more work. Scope
on the upside may extend into the 111.75-112.25 area The trendline off the
mid-August, mid-September and early October lows was taken out on October 25.
At the end of next week, it comes in near 112.70. Resurfacing about it
would lift the technical tone.
Euro: The euro's
recovery from the two-decade low in late September near $0.9535 may have ended with
its approach to nearly $1.01 before last week's ECB meeting. Corrective
forces pushed the euro to a three-day low ahead of the weekend near
$0.9925. The MACD is looking toppish. The Slow Stochastic is still moving
higher but is becoming stretched. Initial support is around $0.9880 and
then $0.9840. On the upside, a move back above parity lifts the tone and
seems consistent with the forging of a potentially important low. The initial
dovish read of ECB President Lagarde was reassessed in light of the
acceleration of inflation in the preliminary October reports.
Japanese
Yen: The dollar held above JPY145 last week. Tactically,
this level needs to be broken if Japanese officials are going to inflict pain
on the dollar bulls. The traditional LDP policy prescription of easy money and
fiscal accommodation was underscored by the BOJ, which is continuing to expand
its balance sheet, and Prime Minister Kishida's new spending and subsidy
bill. However, the key to the exchange rate still seems to be US rates.
The BOJ does not have to overcome the trilemma that the consensus narrative
seems to believe. It just needs to buy time until US interest rates peak.
The first technical hurdle is seen near JPY148.50 and a break of it signals
another run at JPY150. The momentum indicators are still falling as the
nearly seven-yen decline beginning from the high on October 21 is still being
detected. The BOJ intervention in late September for almost $20 bln took
place the day after the Fed's last hike.
British Pound: Sterling was
easily the best performing G10 currency last week, appreciating by 2.75%. It was the third consecutive weekly gain. It finished the week
firmly above$1.16 after nearing $1.1640 in the middle of last week, which
corresponds to almost the (38.2%) retracement objective of this year's
decline. The momentum indicators are stretched but there is scope for
additional even if modest gains in the coming days. That said, the
$1.1740-50 area may be sufficiently formidable to keep stronger gains in check
given the over-extended indicators. The $1.1500 area, which had been
resistance previously, may now be support. With a heavy dose of fiscal
austerity about to be delivered, the Bank of England may hike the base rate by
only 50 bp, as it did in August and September rather than deliver on its threat
of a more dramatic move in the face of Truss/Kwarteng's fiscal
stimulus.
Canadian
Dollar: The US dollar extended its pullback after approaching CAD1.40 in
late September. It made a new marginal low for the month on October 27,
slightly below CAD1.3500. The momentum indicators are still falling, but
the resilience of the greenback in the face of the pre-week stock market rally
hints of what may be in store. The US dollar can move into the CAD1.3675-CAD1.3720
area without improving the underlying technical condition. However, gains
through CAD1.3850 negate the topping pattern that seems in the process of
being forged. A break of CAD1.3500 would lend credence to it and suggest
a medium-term target near CAD1.30, which is where the exchange rate was in
mid-September.
Australian
Dollar: After setting a two-and-a-half-year low on October 13 near
$0.6170, the Australian dollar rallied almost 6% to poke above $0.6520 on
October 27. The demand faded and the Aussie gave back some of its recent
gains. It fell briefly through $0.6390 ahead of the weekend to meet the
(38.2%) retracement of the rally since October 13. The MACD and Slow Stochastic
are still trending higher, but if the corrective/consolidative phase has begun,
the Aussie can test $0.6350-65, and possibly $0.6300. A quarter-point
hike from the Reserve Bank of Australia on November 1 will not be as surprising
as it was on October 4.
Mexican
Peso: The peso's resilience continues to impress. Since around
mid-August, the greenback has been mostly trading between MXN19.80 and
MXN20.20. It finished last week slightly below MXN19.80, for the first time since early June. Last
month, on an intraday basis, it reached almost MN19.75. A break of that
area could spur a move toward the MXN19.60 area. The momentum indicators
do not appear to be generating a useful signal. However, the US dollar
finished the week below the lower Bollinger Band (~MXN19.82). The implied
three-month volatility, around 11.4%, is lower than for most G10 currencies.
It has not been below 11% for six months. The central bank does not meet
until November 10 and is expected to match the Fed's move. Separately,
the US dollar firmed to the upper end of the three-month trading range against
the Brazilian real ahead of the weekend run-off. An uncontested outcome could
see move unwind. It traded a little above BRL5.38 before the
weekend. The 20-day moving average (~BRL5.26) is round the middle of the
recent range.
Chinese
Yuan: The yuan initially was sold dramatically after the 20th
Party Congress ended and the dollar reached nearly CNY7.31 on October 25.
Dollar sales by state-own banks onshore and offshore were reported the
following day, and there are suspicions that the People's Bank of China may
have intervened directly. Some link the possible Chinese action with
apparent Bank of Japan intervention in an uncoordinated move but ostensibly to
boost the chances of success. In any event, after managing to drive the
greenback to about CNY7.1635, the dollar bounced back and finished the week
above CNY7.25. According to the BIS triennial survey, the yuan's share of
the $7.5 trillion average daily turnover in the foreign exchange market is 7%
(up from 4% in 2019). This amounts to around $525 bln a day.
Consider that it has recorded a trade surplus of roughly $645 bln in the first
nine months of the year. Not only China, but nearly every country that
runs a trade surplus and has not pegged their currency to the dollar has
experienced depreciation. Capital flows now typically swamp trade flows.
Globally, the BIS estimates, average daily foreign exchange turnover is $7.5
trillion. Annual global trade was nearly $29 trillion in 2021, and the
world's GDP last year was about $96 trillion. While different tactics are
being pursued, China, like Japan and other East Asian countries are trying to
moderate the pace that its currency is depreciating.
Disclaimer
Reviewed by Marc Chandler
on
October 29, 2022
Rating:
