The recent fluctuations in the value of the US dollar appear closely tied to changes in US interest rates. Following the FOMC meeting and the release of October jobs report, the 2Y Treasury Yield experienced a notable decline of 17 basis points, resulting in a broad decrease in the value of US dollar. This decline was particularly pronounced against various currency pairs, with the dollar approaching three standard deviations below it’s 20 day moving average. Initially perceived as a minor correction to the overly extended technical development, the situation escalated into a significant downturn after a lackluster response to the US 30-year bond auction, concluding the quarterly refunding. Additionally comments from FED Chair Powell, which seemed in line with his statements during the post-FOMC press conference, were interpreted by some as less dovish then expected. The US 2-year bond yield rebounded by almost 17 basis points over the past week. While the dolar closed higher against several major currencies in the first four sessions of the week, it slipped slightly ahead of the weekend.
Despite the improved technical outlook for the greenback, we anticipate that upcoming high-frequency US data for the next week will reveal a easing of price pressures after a Q3 stall. More significantly, there are expectations that consumer demand, a key driver of robust Q3 growth, has likely cooled. Although Powell reassures that the FED stands ready to act as needed, the market interpret the situation as not requiring an immediate intervention. Consequently, this could lead a softening of US interest rates and dollar.
A potential meeting between Biden and Xi on the sidelines of the APEC summit, following several high-level meetings, is seen by many as a thaw in the relationship. However, discussions without tangible changes in behaviour may paradoxically bolster the more hawkish elements on both sides, signalling the diplomatic efforts have not yielded the desired outcomes.
Complicating matters, the spending authorisation for the US federal government is set to expire on November 17. If Congress fails to pass another continuing resolution for a full-year appropriations bill, a partial government shut down becomes a looming possibility.
In the upcoming week, two crucial data points will take center stage:
- Consumer Prices
- Retail Sales
Following a year-over-year deceleration in consumer price growth that plateaued at 3.0% in June, the headline CPI increased to 3.2% in July and 3.7% in August, maintaining that level in September. There is an exception of decrease in October, with Bloomberg’s survey forecasting a uptick in headline CPI, potentially moderating the year-over-year rate to 3.3% – 3.4% from the previous 7.7% in October last year.
However, the core rate remains resilent, with the median forecast anticipating a 0.3% increase, possibly maintaining the 12 month rate at 4.1%, a deviation from the previous downward trend observed since March.
For Federal Reserve Officials to gain greater confidence in the inflation trajectory aligning with their targets, a slowdown in demand is required. Notably, consumer spending surged by 4% in Q3 and early indicators like a slight decline in October auto sales (15.50 million SAAR vs. 15.67 million September) suggest a potential deep in October retail sales, marking the first decrease since March. Retail sales primarily encompass good purchases, accounting for approximately $5.9 trillion in the previous year, while services constituted $11.4 trillion. Without a discernible slowdown in US consumption, the prevailing narrative of an economic slowdown could be challenged, impacting speculations in the FED funds futures and swap markets regarding potential cuts in the coming year.
While other high-frequency data points like Producer Price Index PPI, industrial production, housing starts and Treasury International Capital Report on international capital flows are noteworthy, the significance of the investors and policymakers are focused on CPI and retail sales. Over the weekend, Moody’s downgraded the US rating outlook to negative, a move unlikely to have a substantial material impact but more of an embarrassment than a substantive concern. This decision echoes events over a decade ago when S&P revoked the US triple-A rating, and Fitch followed suit a few months ago.
Eurostat might revise its initial estimate indicating 0.1% contraction in the eurozone economy during Q3. The anticipated details are likely to reveal weaknesses in consumption and industrial output. However, unless a significant surprise emerges, the market will need to seek fresh incentives elsewhere. Q4 data includes the October Composite Purchasing Managers’s Index (PMI), which further declined and notable drop in the CPI to 2.9% year-over-year from 4.3% in September. While the CPI estimate may undergo revision, it is not expected to alter the underlying economic picture. Additionally, given the base effect, this is likely the lowest point for the next few months.
At the end of the week, Fitch is set to update its credit rating for Italy, currently carrying a negative outlook with an assessment that places Italy one step into investment grade. Any downgrade could trigger a sell-of in Italian Bonds and potential impact the Euro’s value, though the use of Italian bonds as collateral in operations with European Central Bank (ECB) would remain unaffected, as the ECB considers the highest rating among the top for rating agencies. Italy’s 10 year premium over Germany, which peaked a month ago near 205 bps, finished the week at around 186 bps, just above 200 day moving avarage. The 2 year premium, having reached one-year high of nearly 95 bps in mid-October, closed the week near 72 bps.
After the US employment data the Euro had been around three standard deviations above its 20 day moving average. The subsequent pullback has been rather mild when everything is considered. It overshot the 38.2% retracement objective ($1.0762) on Monday intraday but now it has settled below it. The next retracement will be roughly around $1.065. The consolidative pattern in recent days still looks constructive but in needs to be resolved in short-term. Since the high was set on November 6 near 1.0755, the Euro has met resistance in the 1.0720-25 zone.
The upcoming week holds significant importance for the UK, with two key reports garnering particular attention from the market:
- Employment / Wages
Despite the signes of a cooling labor market, persistent wage stickiness led three Monetary Policy Committee (MPC) officials to support a rate hike in the recent meeting. However, wage growth, having potentially peaked, might have experienced second consecutive monthly slowdown in September. Following
Following this, on November 15, the UK will release the October CPI report and the BOE has already cautioned about a substantial decline. In October 2022, the UK’s CPI surged by 2.0% which will drop out of the 12 month comparison, likely resulting in a much smaller number. A 0.3% increase would bring the year-over-year rate down to 5.0% from 6.7%, marking the slowest pace in two years.
Last week, the BOE’s chief economist, Pill, validated market expectations (around 60%) of a rate cut around the middle of next year, describing them in British fashion as “not totally unreasonable”. Contrastingly, as recent as October 18, the swaps market had priced in a 50% chance of another rate hike by middle of 2024. The UK will also report October retail sales, which seemed to have stabilized following a 0.9% decline in September and a 6.4% annualized rate in Q3, after a 4.4% annualized increase in Q2.
Sterling recently tested a marginal new low just below 1.2190 ahead of the weekend, following slightly better than expected Q3 GDP datas that showed stagnation rather than a small contraction. A late recovery halted a four-day losing streak, settling slightly above 1.2220 which might contribute stabilizing the overall tone.
The October PMI conveyed dual narratives. Firstly, it indicated that the world’s second largest economy is showing signs of weaknesses, despite being on track to achieve this year’s GDP target of 5%. Secondly, the tangible impact of Bejing’s new policy initiatives is not yet fully realized, though discernible indications of financial resource mobilization are evident in the capital markets. In the light of fiscal measures, IMF adjusted its growth forecast for China, increasing it by 0.4% to 5.4% for the current year and anticipating a growth of 4.6% in 2024.
While lending from banks and shadow banks in October may have slowed, both central and local governments recorded a historic issuance of bonds. This, coupled with regulatory requirements and corporate tax deadlines, may have contributed to the liquidity squeeze observed at the end of the preceding month. However, market attention to China’s economic reports, encompassing retail sales, industrial output, investment, and the surveyed jobless rate, appears limited. October did not witness substantial changes despite the extended national holiday might have a provided a boost to retail sales.
Of significant note is the People’s Bank of China (PBoC) is maintaining the benchmark one-year Medium Term Lending Facility rate at 2.50%, unchanged since August 2023. Given the deepening deflationary forces, stabilized Yuan and equities, a rate cut would align with providing the market additional support. Nonetheless, a rate cut would catch the market off guard. Among the eleven economists polled by Bloomberg, only two anticipate a cut, and their projections range between five and 10 basis points.
For the past three months, the dollar has traded within a range of CNY7.25 to CNY7.35, with minimal exceptions. Closing last week near CNY7.2855 after reaching new highs for the week (~CNY7.2935), the greenback’s stability against the yuan is perceived to be a result of both formal and informal mechanisms employed by Beijing. This exchange rate appears to reflect broader movements in the dollar rather than being a product of deliberate “manipulation” by Beijing for commercial advantage. The U.S. Treasury, in its semiannual report, acknowledged this, while still advocating for increased transparency. Over the past 30 sessions, the correlation between changes in the yuan and the Dollar Index has surged to nearly 0.65, the highest in four months.
The Japanese economy appears to have contracted in the third quarter, with Bloomberg’s survey indicating a median forecast of a 0.4% annualized contraction. While domestic economy likely performed better than in the second quarter, when consumer spending dropped by 2.5% and private investment fell by 4%, the net exports contribution from the previous quarter, driven by a 12.9% annualized quarterly rise in exports (especially in hospitality services like tourism) and a 16.5% annualized decline in imports, is not expected to be repeated. Industrial output is also anticipated to have declined. Although additional fiscal support is anticipated, it seems more aligned with next year’s narrative than an immediate boost for this year. The extension of energy subsides is expected to dampen measured inflation, posing a challenge for the central bank when they conclude next April, as the core measure it targets includes energy.
In September, Japanese investors purchased JPY3.3 trillion of US bonds, bringing this year’s total to about JPY15.6 trillion ($111.7 billion). Despite the BOJ doubling the 10Y Japanese Government Bond (JGB) cap to 1.0% at the end of July and to 0.50% in December of the previous year, higher yields at home did not dissuade Japanese investors from exporting savings abroad.
The dollar witnessed a continuous rise against the yen throughout the previous week, marking the first time since August. After settling near JPY149.40 post the US employment data on November 3, the dollar reached a peak around JPY151.65. The highest point for the year was set slightly above JPY151.70 on October 31, with last year’s high closer to JPY151.95. Despite the seemingly one-way market in recent days, one-month implied volatility remains at a trough (~7.1%), less than half of the levels observed in September and October last year when the BOJ intervened. Notably, there has been no apparent pushback from US or European officials against the persistent weakness of the yen. The yen is currently near its lowest level against the dollar since 1998 and is at its weakest against the euro since 2008.
The Reserve Bank of Australia (RBA) has revised its inflation forecast upward and lowered its projected peak level of unemployment. The latest projection anticipates inflation approaching 3%, at the upper limit of its target by range, by late 2025., marking an increase of about 25 bps from the August estimate. The statement’s language has shifted from suggesting that further tightening “may be required” to acknowledging that future economic data will determine whether sufficient measures have been taken.
Two significant data points are on the horizon.
Firstly, the Q3 wage index will be closely watched, as hourly wages have risen by approximately 0.9% per quarter over the past four quarters, doubling the pace observed in the four quarters through the middle of the previous year.
Secondly, the October employment report, scheduled for release on November 16, is crucial. Job growth has decelerated, with the 3 months average through September at 23.1k a month, half the pace seen in Q1. Notably, Australia experienced an average loss of nearly 18k full-time jobs in Q3, marking the first time the three-month average has been negative since October 2021. Despite this, the labor market’s expansion has slowed, maintaining the unemployment rate in the 3.5%-3.7% range since late last year.
The Australian dollar faced a decline throughout the past week, a trend not observed since August 2022. Despite a quarter-point rate hike that had not been fully factored into the futures or swap market, the Aussie incurred a substantial 2.4% loss, the most significant in five months. This drop surpassed the (61.8%) retracement of its recovery from the year’s low on October 26 (~$0.6270). Momentum indicators have turned lower, and immediate support is identified around $0.6320-30. Stabilizing the technical tone may require a move back above the $0.6415 area.
The upcoming economic data in the coming days are not expected to significantly impact the market. Housing starts through September are approximately 8% below last year’s pace, and existing home sales experienced a decline in Q3 after a positive first half. October’s reports may provide interesting insights, but the sentiment remains cautious about the risk of a recession. Canada is also set to report its September portfolio capital flows, with foreign investors continuing to buy Canadian stocks and bonds, albeit at a slower pace. In the first eight months of this year, foreign investors purchased a net of about C$37.5 billion of Canada’s stocks and bonds, significantly lower than the almost C$125 billion in the same period last year.
The summary of the latest Bank of Canada meeting revealed a divergence of views among board members. While some favor a tighter monetary policy to address resilient core pressures, the majority expects the softer economy to dampen price pressures. However, they caution that the 2.5% increase in federal and provincial spending pushes in the opposite direction. Despite this, the swap market indicates a little over an 80% chance of a rate cut by the end of Q2 2024, with two cuts fully discounted by the end of next October.
The Canadian dollar was on track to decline for the fifth consecutive session before a late recovery helped it avoid further losses. It eked out a modest gain before the weekend, resulting in a weekly loss of about 1%. Before the weekend, the US dollar reached a new high for the week against the Canadian dollar at CAD1.3855. The greenback has surpassed the (61.8%) retracement objective of the recent decline, and the momentum indicators have turned higher. While there may be little on the charts in front of the year’s high set on November 1 near CAD1.3900, the close below CAD1.3800, albeit marginal, may suggest a potentially weaker tone. Initial support may be around CAD1.3750.