Bailey Weighs on Sterling

Overview: The dollar enjoys a firmer tone today. The escalating conflict in the Middle East is keeping the market on edge. And then there is tomorrow's US employment report. Among the G10 currencies, sterling has been the hardest hit. It is off around 1% after Bank of England Governor Bailey seemed to signal that after pausing last month, the central bank may turn more aggressive here in Q4. Nearly all the emerging market currencies are lower. 

Global equities and bonds are struggling. Several markets in the Asia Pacific were closed for holidays. Tokyo rose on the back of the weaker yen, while Hong Kong saw some profit-taking after its recent surge. Europe's Stoxx 600 is off for the third session this week. It is down about 0.7% after edging up 0.05% yesterday. US index futures also are trading lower. European benchmark 10-year yields are up 5-6 bp today, though with Bailey's comments, UK Gilts are holding in considerably better. The 10-year US Treasury yield is again probing the 3.80% area, which it has not settled above in a month. Gold continues to consolidate within Tuesday's range (~$2632-$2673). November WTI is firm near $71.50 in Europe. Yesterday's high was near $72.50. 

Asia Pacific

Japan and Australia's final September service and composite PMIs drew little attention. In Japan, the focus is on the supplemental budget that the new government is reportedly considering and the election at the end of the month. Separately, Australia reported a A$5.6 bln August trade surplus, which is a little more than half of the August 2023 surplus (~A$10.2 bln). Exports and imports fell by 2%. The stronger than expected August retail sales (0.7% vs. 0.4%) bodes well for tomorrow's Australian household spending report. The strong demand is a consideration keeping the central bank on the sidelines. The market recognizes de minimis chance of a rate cut next month, but the futures market is pricing around a 62% chance of a hike at the December 10 meeting. New Zealand's central bank meets in the middle of next week. It began the easing cycle in August. with a quarter-point cut. The swaps market economists surveyed by Bloomberg are favor a 50 bp cut (to 4.75%).

The rise in US Treasury yields, the confirmation signal that BOJ Governor Ueda is no hurry to hike rates again, broad dollar gains, and some option-related demand, helped the greenback recover from around JPY144 in early North America yesterday. It approached last Friday's high near JPY146.50 in late dealings. Follow-through buying today lifted the dollar to marginally above last month's high (~JPY147.20). The bottoming pattern that appears to have been carved suggests potential back toward JPY150. The rolling 30-day correlation of changes in US 10-year yield and the exchange rate is near 0.76, the highest since last 2021. The US 10-year yield is bumping up against 3.80%, which has frayed on an intraday basis, but the yield has not settled above it for a month. The Australian dollar recorded an inside session on Wednesday. It traded in a narrow 15-tick range around $0.6890. It fell to a five-day low near $0.6845 in the European morning. The next target is near $0.6820. As speculation of a 50 bp cut next week by the RBNZ percolates, the Australian dollar has broken higher against the New Zealand dollar. The Aussie reached NZD1.1020 today, its best level since August 20, which corresponds to the (61.8%) retracement of the Australian dollar's losses since peak in late July around NZD1.1150. Before getting there, the Aussie must overcome resistance near NZD1.1050. The yen's drop and rise in US yields proved too much the yuan. The dollar rallied to new session highs near CNH7.0370 the North American afternoon yesterday and overcame the resistance that had capped it earlier in the session. Follow-through buying pushed it above CNH7.05 today. Nearby resistance is seen near CNH7.0640 and then CNH7.07. 

Europe

The sub-2% eurozone CPI reported earlier this week is the new news, and the market is confident that will be sufficient to induce the European Central Bank to cut rates later this month, and again in December. More than that, many participants have begun toying with the idea that the ECB could deliver 50 bp cut at the end of the year, a holiday gift indeed. Today's final PMI reading (revised slightly higher) did not draw much attention, while the August producer prices will underscore the disinflation/deflationary environment. The UK PMI (revised slightly lower) is holding up better than the eurozone’s, but the economy stagnated in June and July. BOE Governor Bailey's interview in the Guardian seemed to signal a pivot toward a more aggressive easing campaign. Sterling was tagged and the odds that rates will be cut by 50 bp before the end of the year rose to above 70% from slightly less than 50% yesterday. It seems that with the onset of the pandemic and the powerful policy response that the Great Moderation was given a eulogy by nearly every bank and research team, though one might have expected the Great Financial Crisis to have delivered the death blow. Yet, Switzerland looks poised to challenge that consensus. First, note that the services PMI has been alternating since February between above 50 and below 50. True to the pattern, the service PMI fell to 49.8 in September from 52.9 in August. The manufacturing PMI has not been above 50 since the end of 2022. Earlier today, Switzerland reported its measure of CPI slipped by 0.3%. It has not risen since May. In the four months through September, Swiss CPI has fallen at an annual rate of about 2.0%. The SNB targets 0-2% inflation. The EU harmonized measure has been more than halved this year. It finished 2023, a little above 2% and it now stands at 0.8%. The SNB has cut rates three times this year, including the quarter-point cut last month. The deposit rate is at 1.0%, and the swaps market is pricing in another quarter-point cut and about a 35% chance of a 50 bp move. In a year, the swaps market is pricing in a 0.25%-0.50% target rate. 

The euro fell for the fourth consecutive session yesterday. It fell through Tuesday's low (~$1.1045) to slightly below $1.1035 as European markets were winding down. It edged lower to $1.1025 so far today. There is little technical support until $1.10. Meanwhile, previous support in the $1.1070-80 area now offers resistance. The US two-year premium over Germany rose to a little above 160 bp (bottomed near 135 bp in mid-September) to its highest level since August 20. The dollar has been pinned in its trough against the Swiss franc. Since late August, the greenback has been confined to a roughly CHF0.8375-CHF0.8550 range. It is a little above CHF0.8500 in the European morning. Sterling set the session high yesterday in early European turnover slightly above $1.33. The session low near $1.3245 was toward the end of the European session. With Bailey's help, sterling was pushed through $1.3200 support to approach $1.31 today. The intraday momentum indicators are stretched. While a break of $1.31 could spur another cent decline, we suspect consolidation in North American today, with $1.3150 offering the initial cap. The euro is recovering against sterling today after falling in six of the past seven weeks. It is at a two-week high near GBP0.8415. 

America

The US has a full economic slate today, but tomorrow's September employment report will likely be more impactful. The US economy appears to be tracking close to 3% for Q3. Today's data are unlikely to change that. That said, the market is more sensitive to ISM services than the final PMI readings. The initial durable goods orders report renders the final reading and factory orders somewhat less significant. The futures market has about a 40% chance of a half-point cut by the Fed next month. It is down from about 50% a week ago. This still seems too much, given Fed Chair Powell's comments and the upward revision to both GDP and GDI. Canada sees its services and composite PMI today. There is not preliminary report, so this is new news. Still, the report is unlikely to impact expectations for the Bank of Canada very much. The swaps market has around a 55% chance of a 50 bp cut at October 23 meeting, and in any event, has nearly 75 bp of cuts discounted in the last two meetings of the year.

There was limited follow-through yesterday after the US dollar posted a bearish outside down day against the Canadian dollar on Tuesday. Support in the CAD1.3460-65 area held, and the greenback recovered to close near session highs near CAD1.3520. Resistance is around CAD1.3540-60. The Mexican peso was among the strongest emerging market currencies yesterday. It rose for the third consecutive session, and the roughly 0.90% gain was the most in two-and-a-half weeks. President Sheinbaum gave foreign investors some assurances at her first press conference. There were, however, conflicting signals from the central bank. The governor opened the door to faster rate cuts provided there were no more inflation shocks. The deputy governor and the only official that voted against the recent cut emphasized the stubbornness of services inflation. Still, it might simply have come down to the short-term market getting caught the wrong way. Alternatively, it could have been a "buy the dollar on Sheinbaum's election and sell on the inauguration. Recall in the two weeks through Tuesday, the dollar had steadily appreciated against the peso by about 3.5%. The greenback reached its best level on Tuesday (~MN19.83) since September 12, before reversing lower to almost MXN19.59. Yesterday's low was near MXN19.34. It is consolidating today in a range about MXN19.40-MXN19.50.

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