The combination of
soft US price data and mostly weaker economic data lends credence to a new
economic convergence. The economic news stream from Europe, Japan, and China is
not particular inspiring. Rather the convergence is driven by the materialism
of the long-anticipated slowdown of the world's largest economy. This new
convergence is negative for the dollar. Our conservative working hypothesis
continues to be that the US dollar's gains from the middle of July are being
retraced. While we suspect that more than just a technical correction is
unfolding, given the high degree of uncertainty and the uniqueness of the
post-Covid business cycle, prudence dictates taking it one step at a time.
The near-term risk is that the market has gotten ahead
of itself. The US data are likely to confirm a sharp slowdown at the start of
Q4, but the market is pricing in nearly four rates cuts by the Federal Reserve,
with around a 75% chance the first one is in next May. It is difficult to
anticipate the pendulum of expectations swinging more in that direction without more encouragement. Fed
officials (and central bankers) may lean against what might be seen as
premature easing of financial conditions. Outside of the preliminary PMI, the
highlights in what will be a holiday-shortened week for the US, are the UK's
Autumn Budget and Canada's CPI. Japan reports its October CPI, but Tokyo's data
a few weeks ago steals its thunder. The oil prices have declined for four
consecutive weeks, taking crude down around 12.5%. The correlation between
changes in oil prices and interest rates/breakevens, is not particularly robust.
Still, if the drop in oil is sustained, and it appears to be helping depress
average retail gasoline prices (in the US), there could be more significant
knock-on effects.
United States: After almost 5% annualized growth in Q3, the world's largest economy is
going to slow in Q4, and the key issue question is the magnitude. The median
forecast in Bloomberg's monthly survey is for a 0.7% expansion on an annualized
basis. Fed Chair Powell was spot-on with his observation that the Summary of
Economic projections are simply snapshot of official thinking and that as the
quarter progresses, the views become dated with new information. Recall that in
December 2022, the median forecast by Fed officials was that the economy was
going to grow by 0.4% this year. It has been steadily lifted and in September
stood at 2.1%. Yet, the US economy has grown by that much through the first
three quarters. Following a slowing of job growth in October and weaker retail
sales and industrial production, the data in the holiday-shortened week ahead
should show more softness.
Existing home sales are expected to have fallen for
the fifth consecutive month in October. Durable goods orders are seen falling
(~3.4%). It would be the third decline in four months. Note that Boeing's
orders slowed to a still strong 119 in October from 224 in September. Its
backlog of orders reached 4,578 planes, worth about $440 bln, and that was
before the latest announcement of new orders from Middle Eastern airlines (~94
planes). The October Leading Economic Indicator Index has been falling without
fail beginning April 2022. The six-month annualized decline has been moderating
since March (-9.0%) to -6.7% in September and this trend may have continued,
albeit slightly in October. The University of Michigan updates is November
survey that showed a rise to 4.4% of the one-year inflation expectations, up
from 4.2% in October and 3.2% in September. Fed officials seem to put more
stock in the 5–10-year expectations. They rose to 3.2% in the initial estimate
up from 3.0% and a new high since 2008. The NY Fed's survey showed one-year
consumer inflation expectations slipped to 3.57% in October from 3.67% in
September. It is a three-month low. The three-year expectation was unchanged at
3.0%. The three-year breakeven (difference between inflation-linked security
yield and the conventional yield) is about 2.2% and the one-year breakeven is
around 2.12% (vs. 2.23% at the end of October). The one-year breakeven is near
2.07% (vs.2.25% at the end of October).
The US also sees the preliminary PMI at the end of the
week. The readings are holding slightly above the 50 boom/bust level. The
composite was at 50.7 in October, a three-month high. It has been below 50
since January. Lastly, recall that the market initially saw the FOMC statement
earlier this month as hawkish but then interpreted the Fed Chair as dovish.
This seemed to be a stretch to us at the time, and, in any event, the market corrected itself
after Powell's comments at an IMF discussion, as if that is where a change
would be announced. Still, the Fed's stance seems straigth-forward: Policy is restrictive,
but it is not clear whether it is restrictive enough. The Fed is prepared to
raise rates again, if necessary. The market judges it will not be necessary.
The futures market has a little more than almost a 75% chance that the first rate
cut will be delivered in May 2024, and it has 92 bp in cuts priced in for all
next year. That is three quarter-point cuts and a 70% chance of a fourth rate
reduction.
The Dollar Index fell by more than 1.7% last week, its
largest decline in four months. It repeatedly tested the 104.00 level since
November 14 CPI report and finally broke through it ahead of the weekend. The low was slightly above 103.80. The
next area of technical support is seen around 103.45-103.60. We suspect it may
head toward 102.55, the (61.8%) retracement of the rally since the mid-July low
(~99.60) to the early October high (~107.35). Resistance may be encountered in
the 104.50 area.
China: Without
a cut in the one-year Medium-Term Lending Facility (MLF) rate last week,
Chinese banks seem to be under little pressure to reduce their prime rates. In
fact, recall that following August's 15 bp reduction in the MLF rate (to
2.50%), the one-year loan prime rate was cut by 10 bp (to 3.45%), while the
five-year loan prime rate has been steady at 4.20%. Still, the PBOC offered
CNY1.45 trillion (~$200 bln) through the MLF, which is more than double the
amount of funds coming due this month. Some argue that this injection is roughly
the equivalent of a 25 bp cut in reserve requirements. Next week, the PBOC will
issue CNY45 bln (~$6.2 bln) in T-bills in HK. This may absorb some of the
excess liquidity and support the yuan. Reports suggest that ahead of Biden-Xi
meeting, China's buyers, including Sinograin, bought 3 mln metric tons of
soybean in almost a dozen agreements struck. US beans are more expensive than
Brazil's, but these beans may be headed for storage. With less moisture and
lower oil content, US beans may store better. Other reports suggest China is
considering buying Boeing's 737 Max airplane. On the other hand, the day before
the heads of state meeting, the main US federal government pension fund
announced that it would adopt a new benchmark which excludes Hong Kong, in
addition to China, which had previously been dropped.
The yuan's 1% gain last week was the most in in four
months. The dollar peaked in September near CNY7.35 and approached CNY7.2050
ahead of the weekend, its lowest level since mid-August. A break below CNY7.19
could signal a move toward CNY7.10-12. The rolling 30-day correlation between
changes in the yen and offshore yuan reached a new high for the year near 0.69
ahead of the weekend. The 60-day correlation is near 0.57 and the high for the
year was set in April closer to 0.60. The correlation between changes in the
euro and offshore yuan are firm though lower than the yen.
Japan: Japan's
CPI will draw media attention and headline traders, but the new information is
very limited. The Tokyo CPI that was reported on October 27 is the signal. What
it is telling us is that the national measure most likely rose again. The
headline rate may rise from 3.0% toward 3.4%. The core measure, which excludes
fresh food, may have risen to 3.0% from 2.8%. The measure that excludes fresh
food and energy was unchanged in Tokyo (3.8%), while the national measure was
at 4.2% in September. Bank of Japan Governor Ueda is putting more weight on
wages. This year's spring wage round produced an average base pay gain of
3.99%, the most in 30 years. Yet, real household spending s 2.8% lower
year-over-year in September. It has not been positive since October 2022. The
weakness of the yen and the end of the pandemic has seen tourist flock to
Japan. Tourism last month surpassed tourism in October 2019. Tourists from
South Korea were up three-fold from October 2019, while visitors from Taiwan,
Singapore and the US surpassed the trips pre-pandemic too. Chinese tourists
were the largest before the pandemic and were off by around 65% last month from
pre-pandemic levels.
The dollar returned to this month's low near JPY149.20
ahead of the weekend. Falling US rates and a short squeeze in the JGB market
seemed to be the key drivers. The 10-year (generic) JGB yield was slightly
above 0.97% at the start of the month, and, at the end of last week, spiked to
about 0.72%, the lowest since late September. The five-day moving average
(~JPY150.75) has not traded below the 20-day moving average (~JPY150.50) since
the end of July. A crossover now could be a proxy for moving average crossover systems
behind some model-driven segments. Below JPY149.20 is the low from late October
(~JPY148.80) for intermittent support ahead of JPY148.00.
Eurozone:
We suspect the eurozone economy is bottoming out. It does not mean that there
are strong growth impulses, but the drip feed of poor economic news may be
ending. The main report in the week ahead will be the flash PMI. The readings
are so weak that it will likely take a several months for the composite (46.5
in October) to recover above the 50 boom/bust level. The market has almost a
90% chance that the ECB delivers its first cut in April 2024, and nearly a 90%
chance that three cuts are delivered by the end of Q3 24. The market did not
punish Spain for the political uncertainty following the July elections and the
reaction was muted when Sanchez secured his third term as prime minister. The
price will be greater dependence on the Catalan separatist. Portugal is in a
somewhat different position. A corruption probe has toppled the Costa
government and an election will be held in March 2024. The 10-year yields in
Portugal and Spain fell by 17-18 bp last week, seeing their premium over
Germany narrow by around five basis points. Lastly, we note that Moody's upgraded the outlook for Italy's credit to stable and affirmed its lowest
of investment grade status. The 10-year Italian bond yield fell 20 bp last week.
The eurog pushed to $1.0915 at the end of
last week, its best level since the end of August. The next upside target is
the high from late August around $1.0945 and the (61.8%) retracement of the
decline from the mid-July high (~$1.1275) that is found near $1.0960. Momentum
indicators are rising but getting stretched. Initial support has formed around
$1.0825. Better support may be found closer to $1.08, which holds the
200-day moving average and the (38.2%) retracement of the rally from the
November 10 low (~$1.0655).
United Kingdom:
The UK Chancellor of the Exchequer Hunt presents the Autumn Statement on fiscal
policy on November 22. There appears to be pressure from the Tories to allow
fully expensing (deducting from taxable profits) investment in machinery and
buildings, which Hunt estimates will cost the government GBP10 bln. Hunt has
also promised to address labor supply and build on the 30 hours of free
childcare announced in the Spring Budget. The Tories continue to trail behind
Labour by a wide margin. The UK must hold an election by the end of January
2025, and many expect it to be called late next year. The UK also sees its
preliminary November PMI. The composite fell back below 50 in August and has
not been able to resurface the threshold. The UK economy stagnated in Q3 and
the median forecast in Bloomberg's monthly survey look for stagnation to
continue this quarter and next. After stronger jobs growth and softer
inflation, the UK reported a disappointing 0.3% decline in October retail sales
ahead of the weekend. The swaps market is pricing about a 55% chance of a cut
next May and it has two rate cuts fully discounted by the end of Q3 24.
Sterling had a good week, rising by about 1.5% against
the dollar, but it was front-loaded. The high for the week was set on Tuesday
after the US CPI a little above $1.25, its best level in two months. It
consolidated lower in the second half of the week mostly between
$1.2375-$1.2460. The momentum indicators suggest there may more near-term
upside potential. Last week, sterling met the (38.2%) retracement objective of
the sell-off since the mid-July high (~$1.3140) found near $1.2460. The next
retracement (50%) is near $1.2590. A break of $1.2350 would be disappointing,
while falling below $1.2300 would suggest the upside correction might be
over.
Canada: There
are three highlights in the week ahead. First is the October CPI on November
21. The base effect suggests the headline rate may ease back toward 3.3%.
Recall that it bottomed in June at 2.8% and rebounded to 4.0% in August before
slipping to 3.8% in September. Canada's CPI rose at an annualized rate of about
3.6% in Q3 after 4.8% in Q2 and 5.2% in Q1. The Bank of Canada puts an emphasis
on the underlying trimmed and median core rates and has expressed concern about
the lack of progress in recent months. The trimmed mean has been chopping
between 3.6% and 3.9% since May, while the median core rate has been 3.8%-4.1%.
Second, a few hours later, the Canadian government will provide its fall
economic update. It might not be market-sensitive in itself but the Bank of
Canada recently suggested that the fiscal policies of the federal government
and provinces may be contributing to the inflation challenge. Third, at the end
of the week, Canada reports September retail sales. Consumption slowed sharply
in Q3, rising by only 0.2% (seasonally adjusted annual rate) after Canadian
consumer splurged in Q2 (4.7%). August's 0.1% decline in retail sales probably
overstated the case and small gain is likely.
The Canadian dollar was the weakest of the G10
currencies last week, with around a 0.6% gain. The yen, which was the second
weakest, rose 1.25%. The Canadian dollar often lags in a soft US dollar
environment. Still, we suspect the greenback is carving out a topping pattern
against the Canadian dollar. If this is to remain a valid working hypothesis,
the US dollar needs to hold below the CAD1.38 area. The momentum indicators are
trending lower and the five-day moving average (~CAD1.3730) is below the 20-day
moving average (CAD1.3770). On the downside, it would ideally close below
CAD1.3675 at the end of the week ahead.
Australia: The
minutes from this month's central bank meeting, which decided to lift the
target rate for the first time since June will be published on November 21. It
was the first hike under the leadership of Governor Bullock. The swaps and
futures market still have the risk of another hike discounted. The preliminary
November PMI will reveal whether October's decline in the composite to a new
low for the year (47.6) noise or the signal. There are two other developments
to note. First, it looks increasingly unlikely that Australia will conclude
free-trade agreements with either the UK or the eurozone until at least well
into next year. Second, the center-left government announced it would scrap
more than 50 rail and road infrastructure projects due to cost overruns and
fears, underscored by the IMF, that significant infrastructure spending
threatened to worsen price pressures. The government may project new funding
for infrastructure in its mid-year economic review expected in the coming
weeks, while pursuing a 50/50 split with state governments.
The Australian dollar had a good week, gaining
slightly more than 2.4% on the greenback to reach its best level in three
months. It was the third consecutive week that the Aussie has had a net change
of 2% or more. It has not done this since August-September 2021. The Australian
dollar peaked in the middle of last week near $0.6540 and spent the last two
sessions consolidating. It found support ahead of $0.6450. Around $0.6510, the
Aussie met the (38.2%) retracement of the decline from the mid-July high
(~$0.6900). The next retracement (50%) is about $0.6585, and the 200-day day
moving average is a little higher (~$0.6595). The momentum indicators are
rising but getting stretched.
Mexico: The initial estimate that Q3 GDP rose by 0.9% quarter-over-quarter is
subject to revision, but it makes the September retail sales report on November
22 somewhat less important for the market. The CPI for the first half of
November is more interesting. We note that the pace of improvement appears to
be slowing. A few hours after the CPI report, minutes from November 9 central
bank meeting will provide some more insight into how officials are thinking
about the economy. Recall that the statement after the meeting modified the
language around how long the overnight target will be kept at 11.25% from
"a long time" to "some time". The central bank also trimmed
its inflation forecast to an average of 4.4% in Q4 23 (from 4.7%) and 4.3% in
Q1 24 (from 4.4%). Separately, Argentina's run-off presidential election is on
November 19. Regardless of the results, Argentina's economy is in a difficult
place, with triple-digit inflation, over-indebted, and low international
reserves. A large devaluation seems nearly unavoidable.
The greenback reached almost MXN17.94 on November 10,
reversed lower and recorded a low near MXN17.19 at the end of last week. After
settling lower for five consecutive sessions, the dollar eked out a small gain
before the weekend. The momentum indicators are still falling, and chart
support is not seen until MXN17.00-10. Initial resistance may be around MXN17.
35.
Reviewed by Marc Chandler
on
November 18, 2023
Rating:
