The market had been gradually pulling back from expectations of a 50 bps cut by Federal Reserve this week. The Euro and Sterling tested technical levels near 1.10 (EUR/USD) and 1.30 (GBP/USD) respectively. The Dollar Index reached last week’s high following the August CPI. However, the overall market tone shifted, sparked by initially by Dow Jones story that many believe was planted by a senior FED official to bring the possibility of a 50 bps cut back into play. This caused a sharp reaction, with the odds of a 50 bps cut rising to nearly 50% by the end of the week, up from less than 20% after Wednesday’s CPI release. Several former FED officials were quoted, expressing support for a larger move. The Dollar fell against most major currencies in the last two sessions, sinking the new lows for the year against the Japanese Yen, near 140.30.
The FED is generally seen as reluctant to surprise the market. Many expect another media story during the quiet period before the FOMC meeting to reduce the risk of a surprise. It is rare for odds to be so close to 50/50 when it is so close to an FOMC meeting. The FOMC meeting and press conference will be the key events in the upcoming days.
The Bank of England, Norways’s Norges Bank, and the Bank of Japan also meet, though none of them expected to act immediately. However, it has been obvious, market is pricing in 50 bps of cuts by the BOW and 25 bps cut by Norges Bank before the year-end. On the other hand, swap market has priced in a 10 bps rate hike by the BOJ by December.
United States
Before the FOMC meeting concludes on September 18, data on August retail sales, industrial production, and housing starts will be released. While this data is unlikely to significantly influence market expectations for Fed policy, it will help economists refine their Q3 GDP forecasts. August retail sales already disappointed, showing a seasonally adjusted annual rate of 15.13 million units, the weakest since January, though still 0.5% higher than sales in August 2023. The average pace of auto sales this year is about 1% above the average for the first eight months of 2023. Industrial output may have posted a small gain after falling by 0.6% in July. Despite discussions of reshoring manufacturing to the U.S., the country has shed about 32k manufacturing jobs this year through August, compared to a gain of 12k in the same period in 2023. Manufacturing output is flat year-to-date through July, after rising by 1.4% in the January-July 2023 period. Housing starts are running about 5% below 2023’s pace, which itself was about 13% below the 2022 rate. The Atlanta Fed’s GDP tracker stood at 2.5% as of September 9, while the NY Fed tracker was at 2.6% as of September 6.
The FOMC meeting is highly anticipated, as it is expected to mark the beginning of the easing cycle. The key question is whether the Fed will opt for a 25 bp or 50 bp cut. Earlier in the summer, when market volatility peaked between mid-July and early August, there was strong confidence in a 50 bp cut, but as markets calmed, those odds were scaled back. However, the Dow Jones report on September 12 reignited speculation of a larger cut. Even a 25 bp cut could be delivered with a dovish tone, especially if there’s no pushback against expectations for at least one, and possibly two, 50 bp cuts at the next two meetings on November 7 and December 18. Unlike his predecessors Bernanke and Yellen, who often downplayed the Summary of Economic Projections (the “dot plot”), Powell embraces these projections, using them while acknowledging their limitations. The dot plot reflects Fed officials’ forecasts based on current data, which can become outdated as more data comes in. In June, the median dot indicated one rate cut, but eight officials anticipated two cuts. The new median is expected to be outside the June range, likely reflecting 75 to 100 bp of cuts. A critical issue is whether the Fed’s more aggressive stance for this year will front-load what it had previously expected to deliver in 2025 and 2026, or if additional easing is anticipated. In June, the median dot projected the Fed funds rate would finish 2025 between 4.00% and 4.25%, and between 3.00% and 3.25% by the end of 2026. However, Fed funds futures currently imply a rate of about 2.75% by the end of 2025 and 2.85% by the end of 2026.
Until the latter half of last week, it seemed the dollar’s upward correction from its August decline had not yet ended. However, the Dollar Index stalled near 101.85 last week and failed to breach the previous week’s high, slightly above 101.90. The index gapped lower ahead of the weekend, setting the week’s low just below 100.90. The lower end of the range sits at 100.50. Momentum indicators are mixed, but the risk of a 50 bp cut may discourage dollar buying at the start of the new week.
Eurozone
After last week’s ECB rate cut and grim forecasts, this week’s high-frequency data is unlikely to significantly alter expectations for next month’s ECB meeting. At the end of last week, there was nearly a 45% chance of another rate cut in October being priced in. The euro closed slightly higher for the week, marking its sixth weekly gain in the last seven, but this didn’t reflect positive developments in the eurozone. Q2 growth was revised down to 0.2% from 0.3%, and Germany’s economy remains sluggish. Industry continues to struggle, highlighted by Volkswagen’s difficulties. German industrial production dropped 2.4% in July (month-over-month), and the manufacturing PMI fell for three consecutive months through August to 42.4, down from 43.3 in December. The September ZEW survey results will be released on September 17. After 11 straight months of improvement, the expectations component fell in July and August, reaching 19.2 in August, the lowest level since January. The assessment of current conditions has fluctuated but remained essentially flat at -77.3 in August, compared to -77.1 in December 2023. News that Germany’s trade surplus unexpectedly shrank by a third over the two months through July is likely to weigh on the EMU trade balance due on September 16.
The euro’s exchange rate is expected to continue being driven more by U.S. developments than European factors. The U.S. two-year yield has dropped significantly faster than the German yield, with the U.S. premium shrinking to about 135 bp from a high near 205 bp in mid-April. It rose to 150 bp in the middle of last week, following the U.S. CPI release, before falling again amid renewed speculation of a 50 bp rate cut by the Federal Reserve. Last year, the spread bottomed near 112 bp, which seems like a reasonable medium-term target. After $1.10 held on September 11 (the 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 U.S. jobs data was $1.1155, and the year’s high, set in late August, was just above $1.12.
United Kingdom
In late July, the swaps market briefly considered the possibility of a Bank of England rate cut this week, but the odds never rose above a 50/50 chance. Now, the likelihood is seen at less than 20%. After this week’s meeting, there are two more scheduled before year-end, with the market pricing in two cuts. Two quarter-point cuts would bring the base rate to 4.5%, and the swaps market anticipates the rate dropping to around 3.60% by mid-2024. Ahead of the BOE meeting, August CPI data will be released. The UK’s headline inflation rose at an annualized rate of less than 1% in the three months through July, potentially overstating the disinflationary trend. However, there is room for a decline in the year-over-year rate (2.2% in July) for both August and September, before firming up again in Q4 and into January 2025. The core inflation rate has been more persistent, but 1) it has not increased year-over-year since May 2023, and 2) it has been more than halved from 6.9% in July 2023 to 3.3% in July 2024. Services inflation has been stickier as well, standing at 5.2% in July, though it has steadily declined from 6.5% in January. Slower wage growth is expected to contribute to a further reduction in services inflation. Last week, the UK reported a 4.0% increase in average weekly earnings (three-month, year-over-year), the slowest since late 2020. August retail sales will be reported at the end of next week. On a volume basis, UK retail sales (including gasoline) have increased by an average of 0.6% per month. However, despite the UK economy being the fastest growing among the G7 in H1 2024, consumption appears to have been a drag, although it is expected to improve this quarter as overall economic growth slows from 0.6% quarter-over-quarter in Q2 and 0.7% in Q1 2024.
Sterling’s pullback early last week brought it close to $1.30, surpassing the 38.2% retracement of the August rally but falling short of the 50% retracement, which is near $1.2965. Sterling benefitted from the broad decline in the U.S. dollar amid speculation of a half-point cut by the Fed, rising above $1.3150 before the weekend, which coincided with a retracement target of the losses sterling suffered following the U.S. jobs data on September 6. Sterling then reversed, recording a session low near $1.3115 before consolidating. We are not convinced this bounce marks the start of a new leg up. Instead, we suspect sterling will retest the lows near $1.30 before approaching last month’s high (~$1.3265). Nearby resistance is seen around $1.3165.
China
The Federal Reserve’s rate cut and clear indication of further cuts may pave the way for the People’s Bank of China (PBOC) to ease its policy as well. Amid a broad decline in the U.S. dollar, the yuan strengthened to its highest levels of the year. The yuan’s strength reached a point where news outlets reported that state-owned banks were buying dollars. The dollar rebounded in the first half of last week before dropping to a four-day low ahead of the weekend. While banks are set to establish prime rates this week, they seem to be holding off until the PBOC takes action. The relationship between state-owned banks and the state is up for debate. The prevailing view is that when these banks participate in the foreign exchange or bond markets, they are acting on behalf of the government. However, these same banks have resisted Beijing’s efforts to push lending to property developers and avoid purchasing government bonds. If these banks did indeed buy dollars, as press reports suggest, after selling them above CNY7.25 in July, the question arises: who benefits from the profits?
Meanwhile, China’s CSI 300 has only seen gains in three weeks since mid-May and has dropped 5% over the past two weeks. It has returned to levels last seen in February, which was a low point dating back to early 2019. Despite Chinese officials’ tight management of the yuan’s exchange rate, the currency continues to closely follow the yen. The yen’s recent gains have helped the offshore yuan post a three-day advance. For the week, the dollar ended almost unchanged—slightly higher against the offshore yuan and slightly lower against the onshore yuan.
Japan
A common narrative is that the shift in the Bank of Japan’s (BOJ) monetary policy caused significant market disruption. While there is some truth to this, correlations suggest two key points: 1) the exchange rate has been more responsive to long-term interest rates than short-term rates, and 2) the exchange rate is more sensitive to U.S. interest rates than Japanese rates or changes in rate spreads. The market is confident the BOJ will maintain its current stance this week, allowing the late July rate hike and the start of quantitative tightening (QT) to be fully absorbed by businesses and investors. The swaps market has priced in an eight basis point hike for this year and an additional 10 bp for the first half of next year. Despite this, the yen has remained strong, with Japanese investors continuing to purchase foreign assets (resulting in yen sales), while speculators in the CME futures market have extended their net long positions on the yen.
Before making its decision, the BOJ will review August CPI data, though the already-reported Tokyo CPI suggests the national report will add little new. That said, headline CPI is expected to have risen above 3.0%, marking a new high since last October, after sitting at 2.8% for the past three months. The core inflation rate, excluding fresh food, likely rose for the fifth consecutive month, reaching 2.6%, which would also be the highest since last October.
The dollar dropped to a new low for the year near JPY140.30 ahead of the weekend, likely pulled down by softer U.S. rates. What made BOJ interventions effective in the past was officials’ skill in timing their actions with peaks in U.S. yields, as they did in 2022. Few accounts highlighting the success of these interventions acknowledge this factor. Currently, the U.S. 10-year yield may form a base around 3.60%, approximately 90 bp below its early July high. If this level holds, it could ease some downward pressure on the dollar, with risk-reward dynamics shifting as the JPY140 level is tested. This level held in late 2023, and the dollar hasn’t traded below it since July 2023. Initial resistance may be found near JPY141.00, but a move above JPY141.50 could be more significant.
Canada
Barring any new shocks, the Bank of Canada is expected to cut rates at its final two meetings of the year (October 23 and December 11), a likelihood that will likely be reinforced by the minutes from the recent central bank meeting. This week’s CPI data, coupled with growing confidence in the Fed’s easing cycle, could increase the chances of a 50 bp rate cut, especially following the disappointing jobs report that saw a loss of nearly 44k full-time jobs and an increase in unemployment to 6.6% from 6.4%. Bank of Canada Governor Macklem left the door open for this possibility last week. Consumer inflation continues to ease, and a modest 0.1% rise in August’s CPI could bring the year-over-year rate down to 2.1% from 2.5%. The three-month annualized inflation rate is expected to be around 1.6%, with core inflation measures also anticipated to have fallen. Other data, such as July retail sales, is expected to show a rebound after a 0.3% decline in June but is unlikely to have a major impact. Portfolio flows for July will also be released on September 18. In Q2, foreign investors net-purchased C$67 billion in Canadian bonds and stocks, the highest in a three-month period in years. The Toronto Stock Exchange Composite rallied nearly 5.7% in July, its best month of the year and second-best since November 2020, with an additional 1% gain last month. The 10-year yield fell by 35 bp, outpacing the previous two months combined.
The U.S. dollar extended its recovery against the Canadian dollar following its August decline but fell short of the 38.2% retracement target near CAD1.3635. It pulled back in recent sessions, holding around the CAD1.3565 area, which is itself a retracement target of the greenback’s rally since the September 6 jobs report low. The greenback finished slightly stronger for the second consecutive week, after a four-week slide. Momentum indicators remain positive, and unless there’s a break below the CAD1.3550 area, a retest of the CAD1.3625-50 zone is anticipated.
Australia
Australia’s August jobs report, set for release on September 19, is the key data point of the coming week. It may help the Reserve Bank of Australia (RBA) further convince investors that rate cuts are unlikely in the near term. Despite the RBA’s firm pushback against rate cut speculation, the futures market is still pricing in about an 80% chance of a cut by the end of the year. Through July, Australia has created nearly 320k jobs (273k full-time), compared to 245k jobs (168k full-time) in the first seven months of 2023. However, the unemployment rate has risen gradually to 4.2% from 3.9% at the end of last year, largely due to a higher participation rate, which increased from 66.6% in late 2023 to 67.1% in July. Population growth from migration has also contributed to the labor market dynamics.
The Australian dollar initially extended its decline from the late August high of $0.6825, dropping to almost $0.6620 mid-last week, just above its 200-day moving average. A broad pullback in the U.S. dollar saw the Aussie recover to nearly $0.6735 before the weekend. If resistance in the $0.6750-$0.6770 zone is overcome, it could re-target the previous high. However, we remain skeptical that the uptrend has fully resumed.
