The market had been gradually scaling back from speculation of a 50 bp cut this week by the Federal Reserve. The euro and sterling tested important technical support near $1.10 and $1.30 respectively. The Dollar Index set last week's high after the August CPI. However, the general tone of the markets changed, spurred at least initially by a Dow Jones story that many observers believe was likely planted by senior Fed official to put a 50 bp cut back on the table. That set the proverbial cat among the pigeons. The odds of a 50 bp cut went up to nearly 50% fat the end of the week from less than 20% at Wednesday's settlement after the August CPI. Several former Fed officials were quoted on the news wires, sympathetic to a larger move. The dollar fell against nearly all the world's currencies in the past two sessions and the greenback sunk to new lows for the year against the Japanese yen near JPY140.30.
The Federal Reserve is perceived to be reluctant to surprise the market. Many seem to expect another media story during the quiet period, where Fed officials do not talk to the media shortly before an FOMC meeting, to minimize the risk of surprise. Rarely this close to an FOMC meeting have the odds been so close to 50/50. The FOMC meeting and press conference is the key event in the coming days. The Bank of England, Norway's Norges Bank, and the Bank of Japan meet. They are not expected to move but market is pricing in 50 bp of cuts by the BOE and a quarter-point cut by Norges Bank before the end of the year. The swaps market has a 10 bp rate hike by the BOJ nearly discounted in December. Several emerging market central banks meet too, but the most interesting will be Brazil. Brazil's central bank began cutting the Selic rate in August 2023, and through May, it had slashed it by 325 bp to 10.50%. At the meeting on September 18, a few hours after the Federal Reserve, Brazil is expected to deliver a 25 bp rate hike. Yet, the strongest emerging market currency last week was the Mexican peso. Its 3.4% gain was nearly twice the rise of the second-best performing EM currency, the Chilean peso (+1.85%). It was the largest weekly advance of the year and came after the judicial reform was approved by the Mexico's Senate and the states. AMLO's national guard proposal will be voted on in the coming days.
United States: Before the FOMC meeting concludes on September 18, the August retail sales, industrial production, and housing starts will be reported. The data is unlikely to have significant impact on market expectations for Fed policy but will help economists fine tune Q3 GDP forecasts. We already know that August retail sales disappointed with a 15.13 mln unit (seasonally adjusted annual rate), the weakest since January. Still, of note, it was about 0.5% above the sales from August 2023. The average pace of auto sales this year is about 1% above the average in the first eight months of 2023. Industrial output may have eked out a small gain after falling by 0.6% in July. Say what one wants about the re-shoring manufacturing to the US, but through August, the US has shed about 32k manufacturing jobs this year. It had gained 12k manufacturing jobs in the first eight months of 2023. Manufacturing output is flat this year through July after having risen by 1.4% in Jan-July 2023 period. Meanwhile, housing starts are running about 5% below 2023's pace, which itself was about 13% below the 2022 pace. The Atlanta's Fed's GDP tracker stands at 2.5% as of September 9 and the NY Fed tracker is at 2.6% as of September 6.
The FOMC meeting is momentous. It will begin the easing cycle. The key debate is size: 25 bp or 50 bp? As the market turmoil from around mid-July through early August reached a climax, the market priced in high confidence of a 50 bp cut, but as the markets stabilized, the odds were scaled back. However, a Dow Jones report on September 12, revived the speculation. Even a quarter-point cut may be delivered in a dovish fashion if there is not push back against expectations of at least one and maybe two half-point cuts at the next two meetings (November 7 and December 18). Powell's predecessors, Bernanke, and Yellen, often played down the Summary of Economic Projections (the "dot plot"). Powell embraces them, refers to them, and recognizes their limitations; they are a snapshot of the different Fed officials’ forecasts based on the current information set, which can become dated as the quarter progresses and there is more incoming data. Recall that the median dot in June was for one rate cut, but there were eight officials who saw two cuts being appropriate. The new median is likely to be outside of June's range, and the median dot is likely to be between 75 and 100 bp of cuts. One important consideration is the more aggressive profile for this year going to be front loading what the Fed anticipated it would deliver in 2025 and 2026 or is there some additional easing anticipated. In June, the median dot had Fed funds finishing 2025 between 4.00% and 4.25%. For the end of 2026, the median dot was for Fed funds to be between 3.00% and 3.25%. The Fed funds futures currently imply about a 2.75% rate at the end of 2025 and 2.85% at the end of 2026.
Until the second half of last week, it did not look like the dollar's upside correction to the August slide was over. However, the Dollar Index stalled near 101.85 last week and failed to take out the previous week's high (slightly above 101.90). The Dollar Index gapped lower ahead of the weekend to set the low for the week (slightly below 100.90). The lower end of the range is 100.50. The momentum indicators are not in agreement but the risk of a 50 bp cut may deter dollar buying at the start of the new week.
Japan: A common narrative is that the change the trajectory of Bank of Japan monetary policy caused great market consternation. No doubt there is something there, but the correlations suggest that two things: 1) the exchange rate has been more sensitive to long-term rates than short-term rates and 2) the exchange rate is more sensitive to US interest rates than Japanese interest rates (or to the changes of the spreads). The market is confident that the Bank of Japan will stand pat this week, allowing its late July rate hike and start of QT to continue to be absorbed by businesses and investors. The swaps market has eight basis points of a hike discounted for this year and another 10 bp in the first half of next year. Despite this the yen has remained firm. Japanese investors have continued to buy foreign assets (yen sales), while the speculators in the CME futures market continued to buy yen and extend their net long position. The BOJ will see August CPI figures before it makes its decision, but the Tokyo CPI has already been reported and this means the national report will add little new. That said, headline CPI likely rose above 3.0% for a new high since last October, after a 2.8% rate for the past three months. The core rate, which excludes fresh food, is likely to have risen for the fifth consecutive month, and at 2.6%, it also would be at the highest since last October.
The dollar fell to a new low for the year ahead of the weekend near JPY140.30. It was arguably dragged lower by the softer US rates. What made BOJ intervention successful was that officials were adept at picking a top to US yields as they did in 2022. Few accounts noting the seemingly effectiveness of the intervention even mention this aspect. In any event, the US 10-year yield may form a base near 3.60%, around 90 bp off the early July high. And if it holds, it may take some pressure off the dollar with the risk-reward changing as the JPY140 level was approached. It held in late 2023, and the greenback has not traded below there since July 2023. Initial resistance may be near JPY141.00, but it may require a move above JPY141.50 to be notable.
United Kingdom: In late July, the swaps market flirted with a Bank of England rate cut this week, but it was on a closing basis never better than a 50/50 proposition. The odds now are seen at less than 20%. After this week's meeting, there are two more before the end of the year. The market has two cuts discounted. Two quarter-point cuts this year would bring the base rate to 4.5%. The swaps market sees the rate near 3.60% in the middle of next year. Ahead of the BOE meeting, August's CPI will be reported. The UK's headline inflation rose at annualized pace of less than 1% in the three months through July. This likely overstates the disinflationary pressure, but there is scope for a decline in the year-over-year pace (2.2% in July) in August and September before firming in Q4 and into January 2025. The core rate has been stickier, but 1) it has not risen on a year-over-year basis since May 2023, and 2) it has been a little more than halved from 6.9% in July 2023 to 3.3% July 2024. Services inflation has been stickier still. It was at 5.2% in July. It has fallen steadily from 6.5% pace in January. The slower growth of wages is expected to slow services inflation. Last week, the UK reported a 4.0% rise in average weekly earnings (three-months, year-over-year), the slowest since late 2020. At the end of next week August retail sales will be reported. On a volume basis, UK retail sales (including gasoline) have risen by an average of 0.6% a month. However, consumption is a much larger category and although the UK economy was the fastest growing among the G7 in H1 24, consumption looks like it may have been a drag, but it is expected to be improving this quarter, even as overall economic activity decelerates from 0.6% quarter-over-quarter in Q2 and 0.7% in Q1 24.
Sterling's pullback in the first part of last week took it to almost $1.30. This surpassed the (38.2%) retracement of the August rally but stopped short of the next retracement (50%), which is near $1.2965. Sterling benefitted from the broad pullback in the US dollar amid the speculation of a half-point cut by the Fed. It rose above $1.3150 ahead of the weekend, which itself was retracement target of the losses sterling suffered after the US jobs data on September 6. Sterling was turned back from them and recorded the session low near $1.3115 before consolidating. We are not convinced that the bounce is the beginning of a new leg up. We suspect sterling will retest the lows near $1.30 before last month's high (~$1.3265). Still, nearby resistance is seen in the $1.3165.
Eurozone: After last week's ECB rate cut and somber forecasts this week's high frequency data is unlikely to materially impact expectations for next month's ECB meeting. There was almost a 45% chance of an October cut discounted at the end of last week. The euro closed slightly higher on the week and its was the sixth weekly gain in the past seven weeks, but it did not reflect good news from the eurozone. Growth in Q2 was revised to 0.2% from 0.3%, and the Germany engine is still not firing. Industry is still hobbled, as illustrated by Volkswagen's woes. German industrial production tumbled 2.4% in July (month-over-month). Its manufacturing PMI fell for three months through August to 42.4 (43.3 last December). The September ZEW survey results will be reported on September 17. After 11 consecutive months of improvement, the expectations component fell in July and August, and at 19.2 in August, it was the lowest level since January. The assessment of current conditions has moved around a bit but at -77.3 in August, it is essentially flat since the end of last year (-77.1 in December 2023). News that the Germany trade surplus unexpectedly dropped by a third in the two months through July is likely to exert a drag on the EMU trade balance due September 16.
The driver of the euro's exchange rate is likely to continue to be found in US developments rather than Europe. The US two-year yield has fallen considerably faster than the Germany yield, and the US premium has sunk to about 135 bp from the year's high near 205 bp in mid-April. It had risen to 150 bp in the middle of last week, after the US CPI before taking another leg down on the renewed speculation of a 50 bp cut by the Fed. Last year it bottomed near 112 bp and seems a reasonable medium-term target. After $1.10 held on September 11 (50% retracement of the August rally is about $1.0990), the euro rallied slightly above $1.11 to set a new high for the week ahead of the weekend. The downtrend connecting the late August and early September highs is around $1.1125 to start the new week. The high around the US jobs data was $1.1155 and the year's high set late August was slightly above $1.12.
China: The Federal Reserve's rate cut and clear signal that more will be forthcoming may remove an obstacle to easing by the PBOC. In broad dollar decline, the yuan rose to its best levels of the year. It had gotten sufficiently strong that the news wires were reporting state-owned banks were buying dollars. The dollar recovered in the first half of last week before selling off to a four-day low before the weekend. Banks set prime rates this week, but they seem to be waiting for the PBOC to move first. How the state-owned banks relate to the state is debatable. The dominant view seems to be that when these banks operate in the foreign exchange or bond market, they are doing the bidding of the government. Yet, at the same time, those same banks have resisted pressure from Beijing to lend to property developers and to refrain from buying government bonds. If those banks bought dollars, as press reports suggest, after selling them above CNY7.25 in July, who realizes the profit? Meanwhile, since mid-May, China's CSI 300 has rallied in only three weeks and is off 5% the past two week. It is back to levels seen February, which itself as the low since early 2019. Although Chinese officials closely managed the yuan's exchange rate, it is continuing to track the yen. The yen's gains helped the offshore yuan string together a three-day advance. The dollar settled virtually unchanged on the week--slightly higher against the offshore yuan and slightly lower against the onshore yuan.
Canada: Barring a new shock, the Bank of Canada is set to cut rates at the last two meetings of the year of the year (Oct 23 and Dec 11), and this will likely be underscored by the record of the recent central bank meeting. In fact, this week's CPI coupled with the greater confidence of the Fed's easing cycle, could boost the chances of a 50 bp move, especially after the dismal jobs report (which saw a nearly 44k loss of full-time jobs and a jump in unemployment to 6.6% from 6.4%). Bank of Canada Governor Macklem kept the door open to this possibility last week. Consumer inflation continues to moderate. A 0.1% rise in August consumer prices will allow the year-over-year rate to fall to 2.1% from 2.5%. The three-month annualized rate would be about 1.6%. The underlying core measures are also expected to have fallen. Other data will be less impactful. Canada will report July retail sales and a bounce back after a 0.3% drop in June is expected. Portfolio flows for July will be released on September 18. In Q2, foreign investor net purchased C$67 bln of Canada's bonds and stocks. This is the most in a three-month period in a couple of years. The Toronto Stock Exchange Composite rallied nearly 5.7% in July, its best month of the year and its second-best since November 2020 (and another 1% last month). The 10-year yield fell by 35 bp, more than the previous two months combined.
The US dollar extended its recovery against the Canadian dollar after slide in August but stopped shy of the (38.2%) retracement objective near CAD1.3635. It pulled back in recent sessions but was limited to the CAD1.3565 area, which itself is a retracement target of the greenback's rally since the low from September 6 jobs report day. The greenback finished slightly firmer on the week for the second consecutive week, after a four-week slide. The momentum indicators are still constructive. Barring a break of the CAD1.3550 area, we anticipate a retest on the CAD1.3625-50 area.
Australia: Australia's August jobs report is the only data of note in the coming week (September 19). It may help the central bank persuade more investors that rates are unlikely to be cut soon. Despite the firm pushback against market speculation, the futures market continues to discount around an 80% chance of a cut by the end of the year. Through July, Australia has created almost 320k jobs (273 full-time posts) compared with 245k jobs (168k full-time) in the first seven months of 2023. Still, the unemployment rate has gradually risen to 4.2% from 3.9% at the end of last year. What is happening is the participation rate has risen for 66.6% at the end of 2023 to 67.1% in July. Migration has boosted Australia’s population. The Australian dollar initially extended its pullback from the $0.6825 high set in late August and fell to almost $0.6620 in the middle of last week, just above the 200-day moving average. The broad setback to the US dollar saw it recover to nearly $0.6735 before the weekend. Overcoming resistance in the $0.6750-$0.6770 area could re-target the high. However, we are not convinced that the uptrend has in fact resumed.
Mexico: Mexico reported soft than expected CPI. The headline rate slipped to 4.99% from 5.57% in July. It was the first decline since February. Mexico's CPI bottomed last October (4.26%). The July print was the highest since May 2023. The core rate eased to 4.0% from 4.05%. It has fallen every month since January 2023, when it was at 8.45%. It has not been below 4% since February 2021. The central bank meets on September 26. Banxico cut rates in August and the risks have increased of another cut in September. Recall that in August, it cut this year's growth forecast to 1.5% from 2.4%. The dollar settled above MXN20.00 on September 10 for the first time in two years. It looks set to move higher but posted a bearish reversal the next day by trading on both sides of the September 10 range and settled below its low. Follow-through selling before the weekend sent the greenback to nearly MXN19.19, where the (61.8%) retracement of the dollar's last leg up that began in mid-August is found. A break of that area could see MXN19.00. Given the carry (interest rate differential), it is expensive for short-term momentum and trend followers to be short the without robust momentum. The controversial judicial reform was approved by both chambers of Congress and states and in the coming days, the bill regarding the National Guard will be taken up.
Reviewed by Marc Chandler
on
September 14, 2024
Rating:
