# United States
The dollar gained strength against all the G10 currencies last week, and intriguing developments had a hand in this. Notably, it wasn’t driven by increased US interest rates; rather, the 10-year US Treasury yield dipped, breaking its five-week rise, and the two-year yield stayed steady for the first time in three weeks. Concurrently, other nations saw their rates decrease. This led to the US two-year yield premium over Germany ascending for the fourth consecutive week, marking its highest since June. A similar trend was observed with Canada, as the US premium rose for the sixth time in seven weeks. In contrast, the US discount to the UK shrank to under five basis points, the narrowest it’s been in nearly two months. Meanwhile, emerging market currency indices, both JP Morgan and MSCI, declined for the third week in a row.
The US presidential election is emerging as a significant factor, bringing with it heightened uncertainties. Politics and capital markets perceive risk differently; where volatility equates to risk in markets, risk in politics is gauged by credibility and capability. In this light, the political risk is predominantly associated with a potential Trump victory. His aggressive tariff proposals are projected to initially boost the dollar, as such tariffs may represent a negative shock to US trading partners. Discussions revolve around the magnitude of this shock and potential retaliations.
Looking ahead, four key events are anticipated: China’s potential cut in loan prime rates, the Bank of Canada’s likely 50 basis points rate cut post a sub-2% inflation reading, the Fed’s Beige Book, and the initial October PMI. Anticipated US data includes survey data for October and late Q3 real sector data such as housing sales and orders for durable goods and factories. The Q3 GDP estimate releasing on October 30 won’t see much influence from this week’s data. The Fed’s Beige Book holds significance, as Chair Powell emphasizes it, unlike previous chairs, especially when discussing rate changes. Early forecasts for October nonfarm payrolls — due November 1 — are around 130,000.
The Dollar Index has seen a more substantial correction than initially predicted, boosted by the market’s reacquaintance with the Fed’s guidance, triggering a recovery in short-term US rates. This marks the year’s fourth rally. Initially, the dollar appreciated almost 4% in the year’s first six weeks, followed by a similar rise in March to mid-April. The third rally in June lifted the Dollar Index by over 2%. The latest rally commenced in late September, reaching a 3.7% increase by last week, stopping just short of a retracement found near 104.10. Indicators suggest the momentum may wane, with initial support possibly around 103.00 and 102.45.
# Eurozone
Last week’s ECB rate cut may soften the market’s response to the preliminary October PMI. Should it present a poor figure, it could reinforce market expectations for another rate reduction at the next ECB meeting on December 12. With September’s CPI below 2%, the ECB holds room for action, preemptively signaled by chief economist Lane concerning an accelerated easing cycle amid economic dissatisfaction.
Germany’s economy stands precariously, possibly contracting for a second consecutive year, a scenario not seen since 2002-2003. The upcoming IFO survey on October 25 might reflect dropping expectations over the past four months, with the current assessment not having risen since April, and at 84.4 in September, it’s the lowest since mid-2020. Moody’s review on France’s creditworthiness due October 25 could also weigh in, as France currently holds an Aa2 credit rating compared to a notch lower by Fitch and S&P. Recent months saw France’s 10-year premium over Germany trading mainly between 70-80 basis points, having reduced since Q1 2024 when it was around 45-55 basis points.
Reacting deeper than expected, the euro’s pullback included a double top near $1.12 and its neckline at $1.10 projecting to $1.08, though a decline past $1.0810 was seen last Thursday. For a substantial technical outlook, recovery above $1.0870, and ideally $1.09 is needed. One factor weighing on the euro has been the US two-year premium over Germany, which escalated from almost 135 basis points in mid-September to about 190 before the weekend. This divergence reflects underlying differences in economic performance and central bank outlook adjustments. If the interest rate realignment is nearly complete, the euro might start gaining better traction.
# United Kingdom
The softer September CPI reinforced market expectations for the Bank of England to execute its next quarter-point rate cut on November 7, with a 90% chance priced into the overnight swaps even before the CPI data release. The main question now concerns the subsequent meeting on December 19. Following the CPI report, confidence for a rate cut in December has risen significantly, resting near a 75% probability. Upcoming CBI trends and preliminary PMI data are unlikely to sway this outlook much.
The UK, amidst navigating its first Labour budget amid its initial 100 days, faces a GBP22 billion funding gap. Yet Labour’s campaign pledges rule out VAT, NIH contributions, and income tax hikes. Potential rises in different taxes, like capital gain tax or contributions from businesses and resident foreigners, pose challenges to PM Starmer’s effort to present Labour as business-friendly. Sterling dipped below $1.30 for the first time last week in two months but recovered post the retail sales report. A close above $1.31 could bolster the chances of marking a low. Meanwhile, the euro also hit a new 2 1/2-year low against sterling but must overcome GBP0.8350-80 resistance to boost its technical tone.
# China
Beijing could continue implementing incremental policy adjustments. Though the one-year Medium-Term Lending Facility is likely to stay at 2% following recent cuts, its importance as a policy tool has lessened. However, loan prime rates might face a 20-basis point cut before markets open on Monday. Such a development would bring the one-year rate to 3.15% and the five-year rate to 3.65%. Given the fiscal briefing lacked specifics, focus shifted to the Standing Committee meeting of the National People’s Congress from October 20-24, amidst demands for fiscal backing to spark domestic consumption.
Simultaneously, the BRICS Summit from October 22-24 echoes EU experiences of broadening over deepening, facing hurdles in timely decision-making. At the heart of BRICS lies a contradiction: the Sino-Indian antagonism, and Beijing’s aim to elevate the yuan’s role through the China International Payment System (CIPS) conflicts with supporting rival platforms. While greater usage of national currencies for trade among BRICS is feasible, actual progress remains sluggish, prompting inquiries into the underlying reasons.
With the broad US dollar rebound since late September, it climbed from approximately CNH6.97 to almost CNH7.15 last week. Any ascent beyond this would target the CNH7.18 range and the 200-day moving average of CNH7.2035. Prior resistance around CNH7.10 may now act as support, followed by CNH7.08. Due to unique factors in both Japan and China, the correlation of their currencies has weakened but seems set to strengthen again.
# Japan
The Bank of Japan is expected to maintain its current policy at the October 30-31 meeting, as market preparations have been minimal amidst the impending October 27 national election. Coming after considerable July changes, the BOJ aims for cautious, clear communication. Upcoming Japanese data includes the preliminary October PMI, September’s final machine tool orders, and crucially, Tokyo’s October CPI. The national figure, reported weeks later, mirrors Tokyo’s decline in headline and core measures recorded in September.
Notably, Tokyo’s core CPI peaked at 4.3% in January, before halving to 2.1% in December. Averaging 2.1% for the year’s first nine months, it was 2.0% in September. Interestingly, the yen’s exchange rate has correlated more with US 10-year yield changes than the 10-year differential on a 60-day rolling basis, the highest peak since an early 2020 spike. The US 10-year yield’s current stall near 4.10% may signal challenges for the dollar in extending gains past JPY150.30 witnessed last week, as indicators suggest downward momentum. Initial support may appear around JPY148.85.
# Canada
The Bank of Canada will hold its meeting on October 23, following three rate cuts this year. Governor Macklem hinted at potentially accelerating this pace, supported by last week’s CPI showing scope for action. With inflation at 1.6%, marking the lowest since February 2021, and visible decreases in monthly rates over several months, the swaps market is pricing in an 85% likelihood of a 50 basis points cut, up from 55% a week ago, with another expected in December.
In understanding the Canadian dollar’s decline, it’s important to note Canada’s nominal two-year yield lags nearly 100 basis points behind its US counterpart. This discount expanded by about 35 basis points this month, the largest since 1997. A notable run on the Canadian dollar saw a two-month high near CAD1.3840, and despite rising only three days in three weeks, it remains the best-performing G10 currency this month. A decisive move in the CAD1.3750-CAD1.3850 range may indicate the next significant direction.
# Australia
Australia’s September employment report, indicating stronger than expected job growth, subdued rate cut speculations for the year. With 290,000 full-time positions added in the first nine months of 2024 compared to 143,000 last year, alongside a record-high participation rate of 67.2% and steady 4.1% unemployment rate, the futures market sees less than a 7% cut chance next month, and a 20% probability for December. The preliminary October PMI out on October 24 tends to be less impactful, with the quarterly CPI on October 30 being more significant for market and Reserve Bank policymaking.
The Australian dollar is sensitive to developments in China due to its major trading partner status, impacting both directly and through commodities pricing. Finding support last week slightly below $0.6660, near the rally’s midpoint from August’s low to September’s high, the momentum indicators haven’t shifted upwards but posted a four-day high close before the weekend. A breakthrough past $0.6720 would be constructive, while $0.6760 presents a more significant resistance.
# Mexico
Mexico’s economy could be particularly vulnerable if Trump returns to office. Its economic modernization relies heavily on integration within the North American continent, centered around the US. Trump’s proposed tariffs – including potential rates of 60% on China and 20% on other global goods – might severely impact Mexico, especially the automotive sector which heavily exports to the US, comprising around 85% of production. Depending on retaliation scope, some projections suggest these developments could shrink Mexico’s GDP by 2% by 2028.
Investors remain cautious about any new administration being friendlier than its predecessor, while cooling inflation allows room for Mexico’s central bank to lower rates again by year’s end. The US dollar leaped from about MXN19.24 at the start of last week to breach MXN20.00 last Thursday, turned back due to a bearish market pattern, dipping to MXN19.65, before bouncing back to MXN19.90. Political considerations tied to the US election maintain downside risks for the peso. The US dollar is poised to hold above MXN19.50 and might aim for last month’s high near MXN20.15. Similarly, the dollar is pushing against the upper boundary against the Brazilian real, nearing BRL5.70, with the year’s high at BRL5.8550 in early August.
