Last week may have marked are reversal point. Despite Chair Powell’s assertion that the Fed did not adopt a policy bias favoring easing and reiterated the absence of discussions regarding rate cuts, the market appears to hold a different view. The implied yield of the December 2024 Fed funds futures contract is approximately 4.45%, indicating that the market is factoring in not only the two cuts projected by the Fed in September but also the likelihood of a third cut, with a further possibility (around 60%) of a fourth cut. The market has already fully priced in the first cut by the end of Q2 2024. The disappointing employment report further exacerbated the situation, leading to a decline in US rates and the value of the US dollar.
This development aligns with the emerging narrative of a dramatic slowing in the US economy, following the robust 4.9% annualized pace recorded in Q3. This trajectory is increasingly seen as an inevitable outcome. While it is still early in the data assessment cycle, allowing for a considerable margin of error, the Atlanta Fed’s GDP tracker is currently indicating a 1.2% growth rate for Q4 GDP, and this projection predates the recent employment report and the notable decline of approximately 0.25% in aggregate hours worked in October, representing the most substantial drop in over two years. The realization that the eurozone and UK are experiencing stagnation or worse, coupled with the likelihood of the Japanese economy contracting in Q3 despite accommodative monetary and fiscal policies, does not introduce marginal new information. The factors that initially facilitated the US dollar’s recovery from its mid-year low may now undergo a reversal, largely influenced by the unfolding developments within the United States.
The recent retreat of the US dollar and the decline in interest rates are expected to alleviate some of the pressures faced by the Bank of Japan and the People’s Bank of China. However, the decrease in US rates implies that the quarterly refunding will occur at elevated prices, potentially leading to concerns about demand from segments of the market that are sensitive to price fluctuations. Federal Reserve officials, including Chair Powell, are likely to provide explanations, with Powell scheduled to participate in an IMF-sponsored event on Thursday. China is set to release several politically sensitive data points, such as trade figures, reserves data, and inflation numbers, although the response from financial markets is typically moderate. The Reserve Bank of Australia is set to announce its decision early on Tuesday, and given the recent significant surge in the Australian dollar, the currency appears vulnerable if there is no indication of a hike. Towards the end of the upcoming week, Fitch will update its evaluation of Italy’s sovereign debt, which is presently categorized as BBB with a stable outlook. S&P recently reaffirmed Italy’s BBB rating. Moody’s is scheduled to announce its decision on November 17, maintaining a negative outlook for its Baa3 (=BBB-) rating.
During the relatively subdued week following the FOMC meeting and the release of the US jobs report, there are three key focal points to monitor.
1.Firstly, the attention will be on the issuance of new Treasuries during the quarterly refunding, with some observers attributing a portion of the rise in yields to the increased supply for deficit funding.
2.Secondly, there is a passing interest in the final September trade figures, given that the Q3 GDP indicated a slight drag from net exports. Although the US goods deficit expanded marginally in September, the overall trade deficit has narrowed year-to-date compared to the same period last year. Growth differentials and the robust US dollar are expected to exert downward pressure on the external sector.
3.Thirdly, the report on September consumer credit will be closely scrutinized. Notably, there was an unexpected decline in August, largely driven by a significant drop in outstanding federal government loans, particularly in student loans. Despite elevated delinquency rates, revolving credit, primarily from credit cards, experienced the most substantial gain of the year in August. Market analysts anticipate an overall increase in consumer credit for September, contrasting with the significant rise observed in September 2022.
The Dollar Index recorded a bearish outside down week, fluctuating within the previous week’s range and settling below its low point (approximately 105.35). The ongoing corrective phase appears to be retracing the rally that began at the end of July. The initial target is around 104.40, representing the 38.2% retracement of the rally, while the 50% retracement sits near 103.45, approximately where the 200-day moving average is located. Notably, the Dollar Index opened lower on November 2, and this gap (around 105.50-60) is viewed as a technically significant factor, further reinforcing the bearish technical outlook.
Last week’s preliminary estimate indicating a 0.1% contraction in the eurozone’s Q3 GDP has redirected some attention toward the September data, including the upcoming retail sales report on November 8. Notably, German retail sales fell short of the median forecast in Bloomberg’s survey, recording a 1.1% decline in August. Similarly, France’s broader consumer spending figures revealed a more modest 0.2% increase, half of the projected growth, following a 0.6% decline in August. Germany’s upcoming release of factory orders and industrial output for September will provide further insights. While German industrial production experienced a downward trajectory in the first eight months of the year, factory orders managed to display more resilience despite two significant declines in March and July. Last week, the preliminary estimate of October’s CPI unveiled a softer-than-expected 2.9% year-over-year rate. Considering the base effect, this figure might represent the trough for the next few months. The results of the ECB’s survey of inflation expectations, set to be published on November 8, will be closely monitored. In August, the one-year inflation outlook stood at 3.5%, slightly above the previous trough, while the three-year expectation was at 2.5%, indicating a moderate rise compared to previous months.
Meanwhile, the euro exhibited a bullish outside up week, with fluctuating movements and a settlement above its high point (~$1.0695). Reaching nearly $1.0750, its strongest level since mid-September, the euro’s momentum indicators remain favorable, and the five-day moving average has consistently stayed above the 20-day moving average since October 20. However, caution is warranted and suggesting an upward trend that may be deemed as an outlier. If the euro is indeed correcting the slide observed since late July, when it reached its annual high near $1.1275, the area around $1.0765 marks the 38.2% retracement objective. Beyond this, the 200-day moving average hovers slightly above $1.08, while the $1.0860 area represents the subsequent retracement at the 50% level.
The upcoming highlight of the week is the release of the Q3 GDP report. It’s important to note that the monthly GDP figures can’t simply be aggregated to derive the quarterly GDP figure, as seen in the case of Q2, where the sum of the monthly GDP estimates was 0.7% compared to the 0.2% quarterly GDP. For the UK economy, July witnessed a contraction of 0.6%, followed by growth of 0.2% in August. The September GDP and Q3 GDP will be unveiled simultaneously on November 10. Although the Bank of England (BOE) maintained the base rate at 5.25%, as widely anticipated, it revised down its forecast for Q3 GDP to flat from the previous 0.4% projection made three months earlier, indicating an expectation of stagnation for 2024. Economists surveyed in Bloomberg’s monthly review also anticipate a flat quarter not just in Q3 but also in Q4 and Q1 2024, with downside risks prevailing. Shifting the focus to CPI (Consumer Price Index), a notable decline is expected due to the removal of the 2% surge in October 2022 from the 12-month comparison. UK CPI is still anticipated to be the highest among G7 countries but is projected to hover closer to 5% (down from 6.7% in September). Despite BOE Governor Bailey’s assertion that it’s premature to consider rate cuts, the swaps market suggests otherwise, pricing in a rate cut starting in Q2 2024 and fully factoring it in by late Q3 2024.
In contrast to the sobering BOE forecasts and the market’s anticipation of rate cuts, the British pound exhibited robust performance. Last week saw an increase of over 2%, marking the largest surge since last November. Preceding the weekend, a 1.4% uptick was the most significant advancement since early January, underscoring the impulsive nature of these gains. The sterling reached $1.2390, its highest level since September 20. Closing above the October high (~$1.2335) may potentially drive it another cent or so in the near term, pushing it to test the 200-day moving average and meet the (38.2%) retracement objective from the currency’s decline since the annual high recorded in mid-July (~$1.3140). Notably, the sterling surpassed the trendline connecting the two October highs (~$1.2260). The next technical target might lie in the $1.2435-60 area. While the momentum indicators appear favorable, the sterling settled above its upper Bollinger Band (~$1.2330) and approached the three standard-deviation mark (~$1.2395).
In the upcoming days, there are three key economic highlights from China: trade, reserves, and prices. Additionally, there’s a possibility of a fourth highlight in the form of the monthly lending figures. Notably, despite a decline of just over 6% year-over-year in dollar terms for Chinese exports and imports through September, the same figures denominated in yuan have experienced a much milder drop of less than 1%. The monthly average trade surplus for China has hovered around $70.05 billion in dollar terms, remaining consistent with the average of $69.95 billion recorded in the first nine months of 2022. In yuan terms, the average trade surplus has been approximately CNY489.3 billion this year, compared to an average of CNY459.3 billion during the same period last year.
Considering the recent bond sell-off and the prevailing strength of the dollar, it would not be surprising to witness a third consecutive monthly decline in China’s reserves during October. China’s reserves have garnered significant attention and debate, with some arguing that the reported reserves are underestimated due to the exclusion of the net currency position of state-owned banks, which are separate from the PBOC. However, it is crucial to recognize that reserves are self-declared and reported to the IMF, and China appears to be experiencing capital outflows, evident from the decline in portfolio investment and retained earnings from foreign direct investment.
Another highlight of the week is China’s inflation, which has been relatively subdued. While China’s CPI experienced a drop to 0% in September from 0.1% year-over-year, the nascent economic recovery has likely contributed to an improvement in CPI, although food prices, particularly pork, continue to wield considerable influence. Moreover, deflation in producer prices has been gradually diminishing, with September’s -2.5% marking the least deflation in the past six months.
The retreat of the US dollar is anticipated to aid the PBOC’s efforts to curb the yuan’s depreciation. Following disappointing US jobs data, the greenback fell to CNY7.26, reaching its lowest level since mid-September, with a decline of slightly over 0.5%, the most significant single-session drop since July 25. While technical levels are challenging to predict for a closely managed currency like the yuan, the current weaker tone of the greenback suggests a potential move toward CNY7.20, and possibly even CNY7.10, as short yuan positions are covered. Against the offshore yuan, the dollar may test the CNH7.26 area, followed by CNH7.19. Consistent firmness in the offshore yuan compared to the onshore yuan further supports the notion of a potential shift in the near-term trend.
An often asked question revolves around the Bank of Japan’s relatively subdued response during its recent meeting, especially after downgrading the significance of the 1.0% threshold of the 10-year JGB. The explanation partially lies in the data that was unveiled prior to the central bank meeting. Industrial output, anticipated to rise by 2.5%, only managed a meager 0.2% increase, while retail sales, predicted to grow by 0.2%, actually fell by 0.1%. These figures reinforced the notion that the Japanese economy might have contracted in the third quarter, following a similar trend in the previous quarter, which was offset by inbound tourism countering declines in consumer spending and business investment.
Furthermore, the Bank of Japan remains cautious regarding the sustainability of inflation, despite revising its inflation forecast for the current fiscal year and the following year. The wage round earlier this year, which was initially deemed successful, translated into a mere 0.8% year-over-year rise in August cash earnings, resulting in a real loss of 2.8% after inflation adjustment. Consequently, household spending experienced a 2.5% decline. Japan is also set to report its current account surplus for September, a recurring feature despite persistent trade deficits. This surplus stems from income earned offshore, including interest, profits, dividends, royalties, and licensing fees, contributing significantly to the country’s overall financial position.
Amidst the market response to the BOJ’s recent announcement, the dollar experienced a rally against the yen, climbing from approximately JPY149 to surpass the high for the year slightly above JPY151.70. Despite the subsequent fluctuations, the dollar settled within the JPY149.00-JPY151.70 range, eventually ending the week slightly below the 20-day moving average (~JPY149.80). Although some momentum indicators did not confirm the recent high, thus creating a bearish divergence, the dollar’s close within the previous week’s range neutralizes some negative implications. Should the dollar drop below JPY149.00, it might initially target JPY148.00-50, with a further decline potentially bringing it to the October 3 low around JPY147.45.
The Reserve Bank of Australia is expected to announce its policy decision early on November 7. The recent slightly stronger-than-anticipated Q3 CPI figures, which came in at 5.4% compared to the median forecast of 5.3%, created some unease in the market, prompting speculation on how it might impact policy. New RBA Governor Bullock refrained from providing clear indications regarding the potential impact of these figures on policy. Recent data, including a significant loss of nearly 40,000 full-time positions in September and disappointing October PMI numbers, signal a loss of momentum in the Australian economy. Despite this, an IMF staff report has encouraged tighter monetary policy and reduced government investment to help cool down inflation. The futures market has now assigned a slightly higher probability of over 50% for a rate hike, nearly doubling the previous likelihood assigned before the release of the CPI report. Prime Minister Albanese’s visit to China is noteworthy, but any potential market impact is expected to be minimal at best.
Ahead of the weekend, the Australian dollar rallied to its highest level in two months, buoyed by the broader US dollar retreat and speculation surrounding a potential RBA rate hike in the coming week. Momentum indicators are currently showing an upward trend. Having made six attempts since mid-August, the Aussie finally managed to close above $0.6500, rather than merely trading above it on an intraday basis. However, it is important to note that the currency is trading at nearly three standard deviations above its 20-day moving average (~$0.6525) and settled higher than two standard deviations (~$0.6470). With the Australian dollar having achieved its longest rally since January over the past three weeks, and a notable increase of approximately 2.8% last week, the currency appears vulnerable should the RBA decide against raising rates.
There is growing speculation that Canada may be sliding into a recession, indicated by two consecutive quarters of economic contraction. Canada’s monthly GDP prints from February through August collectively amounted to zero. Additionally, Canada’s two-year yield, which had peaked around 5% in the latter half of September and early October, dropped to a three-month low below 4.50% last week. Previously, as of October 9, the swaps market had been pricing in another quarter-point hike before next July, but it has since fully factored in a cut of the same magnitude. In terms of upcoming economic data, Canada is set to report the IVEY survey on Monday and September merchandise trade figures on Tuesday. Notably, the IVEY survey has exhibited relatively better performance compared to the manufacturing PMI, which has remained below the 50 boom/bust level for the past six months through October. Simultaneously, Canada’s trade balance has deteriorated significantly, with the country reporting an average goods trade surplus of nearly C$2.4 billion in the first eight months of 2022, but a monthly merchandise trade deficit averaging C$750 million this year through August.
Despite Canada’s bleak economic outlook and disappointing jobs data, which included a loss of full-time jobs and a rise in the unemployment rate to 5.7% from 5.5%, the Canadian dollar experienced its most significant weekly gain in seven months, appreciating by approximately 1.50% against the US dollar. This upward movement was more reflective of the US dollar’s performance rather than a vote of confidence in Canada’s prospects. The CAD1.3660 area faced pressure before the weekend, marking the midpoint of the rally since the end of September. A convincing break below this level would signal a potential test on CAD1.3600, followed by CAD1.3500. Currently, the momentum indicators are trending lower, and the Canadian dollar remains above its lower Bollinger Band (~CAD1.3535). Moreover, it settled below its 20-day moving average before the weekend, a situation not seen since late September. Typically, the Canadian dollar tends to lag on the crosses in a softer US dollar environment.