The blend of subdued US price data and generally weaker economic indicators supports the notion of a fresh economic convergence. The economic reports from Europe, Japan, and China are not particularly encouraging. Instead, this convergence is propelled by the anticipated deceleration of the world’s largest economy. This new alignment has a negative impact on the dollar. Our cautious working assumption remains that the gains made by the US dollar since mid-July are undergoing a retracement. While we suspect more than a mere technical correction is unfolding, given the considerable uncertainty and the distinctive nature of the post-Covid business cycle, it is prudent to approach this situation one step at a time.
The immediate concern is that the market may be getting ahead of itself. The forthcoming US data is expected to confirm a significant slowdown at the beginning of Q4, yet the market is currently pricing in nearly four rate cuts by the Federal Reserve, with about a 75% probability that the first one will occur in May of the following year. Anticipating a further shift in expectations in that direction without additional support is challenging. Federal Reserve officials (and central bankers in general) might resist what could be viewed as prematurely easing financial conditions. In the upcoming week, aside from the preliminary PMI, notable events include the UK’s Autumn Budget and Canada’s CPI, although the week will be shortened due to the holiday. Japan will report its October CPI, although the impact may be subdued as Tokyo’s data from a few weeks ago has already captured attention. The decline in oil prices over the past four weeks, totaling around 12.5%, may not exhibit a particularly robust correlation with changes in interest rates/breakevens. Nevertheless, if the decline in oil prices persists and contributes to a reduction in average retail gasoline prices (especially in the US), there could be more substantial ripple effects.
Following nearly 5% annualized growth in Q3, the world’s largest economy is poised to decelerate in Q4, prompting questions about the extent of this slowdown. According to Bloomberg’s monthly survey, the median forecast anticipates a modest 0.7% expansion on an annualized basis. Fed Chair Powell accurately noted that the Summary of Economic Projections serves as a snapshot of official thinking, with views becoming outdated as the quarter progresses and new information emerges. It’s worth recalling that in December 2022, Fed officials predicted a 0.4% growth for the year, but by September, it had been revised to 2.1%. However, the US economy had already grown by this amount in the first three quarters. In light of October’s decelerating job growth, weaker retail sales, and industrial production, the upcoming holiday-shortened week’s data is expected to reflect additional softness.
Anticipated are falling existing home sales for the fifth consecutive month in October and a roughly 3.4% decline in durable goods orders, marking the third drop in four months. Notably, Boeing’s orders slowed to 119 in October from 224 in September, contributing to its backlog of orders totaling 4,578 planes worth about $440 billion. The Leading Economic Indicator Index, consistently declining since April 2022, may continue this trend, albeit slightly, in October. The University of Michigan’s November survey shows a rise in one-year inflation expectations to 4.4%, up from 4.2% in October and 3.2% in September. While the Fed places more emphasis on the 5–10-year expectations, which reached 3.2%, up from 3.0%, marking a new high since 2008, consumer inflation expectations in the NY Fed’s survey slipped to a three-month low of 3.57% for one-year expectations in October.
Additionally, the three-year expectation remained unchanged at 3.0%. The preliminary PMI at the end of the week is expected to hold slightly above the 50 boom/bust level, with the October composite reaching a three-month high at 50.7, below 50 since January. Despite initial interpretations of a hawkish FOMC statement earlier this month, the market corrected itself after Powell’s comments at an IMF discussion. The Fed’s stance remains straightforward—policy is restrictive, though the extent of this restrictiveness is uncertain. The Fed is prepared to raise rates again if necessary, but the market deems it unlikely. The futures market indicates a little over a 75% chance of the first rate cut in May 2024, with 92 basis points in cuts priced in for all of next year, equating to three quarter-point cuts and a 70% chance of a fourth rate reduction.
The Dollar Index experienced its largest decline in four months, falling over 1.7% last week. After repeated tests of the 104.00 level since the November 14 CPI report, it finally broke through ahead of the weekend, with the next technical support area seen around 103.45-103.60. There is a suspicion that it may trend towards 102.55, the (61.8%) retracement of the rally from the mid-July low (~99.60) to the early October high (~107.35). Resistance may be encountered in the 104.50 area.
We believe the eurozone economy is reaching its lowest point, indicating a potential end to the stream of negative economic news. The upcoming key report is the flash PMI, with readings weak enough that it may take several months for the composite (46.5 in October) to rebound above the 50 boom/bust level. The market anticipates a high probability (almost 90%) of the ECB’s first cut in April 2024 and nearly the same likelihood of three cuts by the end of Q3 2024. Political uncertainty in Spain following the July elections did not significantly impact the market, and there was a muted reaction to Sanchez securing his third term. However, Spain may face greater dependence on Catalan separatists. Portugal, with a corruption probe leading to a government change, is in a different position, and an election is expected in March 2024. The 10-year yields in Portugal and Spain fell last week, narrowing their premium over Germany by around five basis points.
Additionally, Moody’s upgraded Italy’s credit outlook to stable and affirmed its lowest investment grade status. The euro reached $1.0915 at the end of last week, targeting $1.0945 and the (61.8%) retracement of the decline from the mid-July high (~$1.1275) at $1.0960. Momentum indicators are rising but becoming stretched, with initial support around $1.0825 and stronger support near $1.08, including the 200-day moving average and the (38.2%) retracement of the rally from the November 10 low (~$1.0655).
On November 22, the UK Chancellor of the Exchequer, Hunt, is set to present the Autumn Statement on fiscal policy. There is mounting pressure from the Tories to allow fully expensing investment in machinery and buildings, a move estimated to cost the government GBP10 billion. Hunt has also committed to addressing labor supply and expanding on the 30 hours of free childcare announced in the Spring Budget. Despite these initiatives, the Tories continue to trail behind Labour by a considerable margin. With the UK mandated to hold an election by the end of January 2025, many anticipate it to be called late next year. Additionally, the UK will release its preliminary November PMI. After dipping below 50 in August, the composite has struggled to surpass this threshold. The UK economy experienced stagnation in Q3, and the median forecast in Bloomberg’s monthly survey predicts this stagnation to persist in the current and upcoming quarters. Despite stronger job growth and softer inflation, the UK reported a disappointing 0.3% decline in October retail sales ahead of the weekend. The swaps market is pricing in about a 55% chance of a cut next May, with two rate cuts fully discounted by the end of Q3 2024.
Sterling had a positive week, advancing approximately 1.5% against the dollar. However, most of the gains were front-loaded, with the weekly high set on Tuesday just above $1.25, marking its best level in two months. Sterling consolidated lower in the second half of the week, mainly fluctuating between $1.2375-$1.2460. Momentum indicators suggest there may be more near-term upside potential. Last week, sterling positioned near $1.2460. The next retracement (50%) is near $1.2520. A break below $1.2125 would be disappointing, while falling below $1.2300 would suggest the upside correction might be over.
The lack of a cut in the one-year Medium-Term Lending Facility (MLF) rate last week has seemingly relieved Chinese banks from significant pressure to reduce their prime rates. Following the 15 basis points reduction in the MLF rate in August (to 2.50%), the one-year loan prime rate saw a 10 basis points cut (to 3.45%), while the five-year loan prime rate remained steady at 4.20%. Despite this, the People’s Bank of China (PBOC) injected CNY1.45 trillion (~$200 billion) through the MLF, more than double the funds due this month. Some argue that this injection is roughly equivalent to a 25 basis points cut in reserve requirements. In the upcoming week, the PBOC will issue CNY45 billion (~$6.2 billion) in T-bills in Hong Kong, potentially absorbing excess liquidity and supporting the yuan. Reports indicate that, ahead of the Biden-Xi meeting, Chinese buyers, including Sinograin, purchased 3 million metric tons of soybeans in nearly a dozen agreements. Additionally, China is reportedly considering the purchase of Boeing’s 737 Max airplane. However, the day before the heads of state meeting, the main US federal government pension fund announced the adoption of a new benchmark that excludes Hong Kong, in addition to China, which had previously been dropped.
The yuan experienced its most significant weekly gain in four months, with the dollar reaching its lowest level since mid-August. After peaking in September near CNY7.35, the dollar approached CNY7.2050 ahead of the weekend. A break below CNY7.19 could signal a move toward CNY7.10-12. The rolling 30-day correlation between changes in the yen and offshore yuan reached a new high for the year near 0.69, while the 60-day correlation is near 0.57. The correlation between changes in the euro and offshore yuan remains firm, albeit lower than the yen.
Japan’s upcoming Consumer Price Index (CPI) will likely draw media attention and interest from traders, but the new information it provides is limited. The Tokyo CPI reported on October 27 serves as a signal, suggesting that the national measure most likely rose again. The headline rate may increase from 3.0% to around 3.4%, and the core measure, which excludes fresh food, may have risen to 3.0% from 2.8%. The measure that excludes fresh food and energy remained unchanged in Tokyo (3.8%), while the national measure was at 4.2% in September. Bank of Japan Governor Ueda is placing more emphasis on wages. This year’s spring wage round resulted in an average base pay gain of 3.99%, the highest in 30 years. However, real household spending is 2.8% lower year-over-year in September, having not been positive since October 2022. The weakness of the yen and the end of the pandemic have led to an influx of tourists to Japan, surpassing October 2019 levels. Tourists from South Korea tripled from October 2019, and visitors from Taiwan, Singapore, and the US also exceeded pre-pandemic levels. Chinese tourists, the largest group before the pandemic, were down by around 65% last month from pre-pandemic levels.
The dollar returned to this month’s low near JPY149.20 ahead of the weekend, influenced by falling US rates and a short squeeze in the Japanese Government Bond (JGB) market. The 10-year (generic) JGB yield, slightly above 0.97% at the start of the month, spiked to about 0.72% by the end of last week, the lowest since late September. The five-day moving average (~JPY150.75) has not traded below the 20-day moving average (~JPY150.50) since the end of July. A crossover now could serve as a proxy for moving average crossover systems behind some model-driven segments. Support below JPY149.20 includes the low from late October (~JPY148.80) before reaching JPY148.00.
The minutes from this month’s central bank meeting, during which the decision to raise the target rate for the first time since June was made, are set to be published on November 21. This marked the initial hike under the leadership of Governor Bullock. Despite the recent increase, the swaps and futures market still factors in the possibility of another hike. The preliminary November Purchasing Managers’ Index (PMI) will shed light on whether October’s decline in the composite, reaching a new low for the year at 47.6, is merely noise or a significant signal. Two other notable developments include the increasing unlikelihood of Australia finalizing free-trade agreements with either the UK or the eurozone until well into next year. Additionally, the center-left government has announced the cancellation of over 50 rail and road infrastructure projects due to cost overruns and concerns about significant infrastructure spending exacerbating inflationary pressures. The government may introduce new funding for infrastructure in its upcoming mid-year economic review, along with a proposed 50/50 split with state governments.
The Australian dollar had a strong week, gaining over 2.4% against the US dollar to reach its highest level in three months. This marks the third consecutive week with a net change of 2% or more, a feat not achieved since August-September 2021. The Aussie peaked around $0.6540 last week and has since spent the last two sessions consolidating, finding support near $0.6450. While momentum indicators are on the rise, there is a risk of them becoming stretched.
The week ahead holds three key highlights for Canada. First on November 21 is the October Consumer Price Index (CPI). The base effect indicates the headline rate may ease back toward 3.3%. After bottoming at 2.8% in June, it rebounded to 4.0% in August before slipping to 3.8% in September.
Canada’s Q3 CPI rose at an annualized rate of about 3.6%, following 4.8% in Q2 and 5.2% in Q1. The Bank of Canada emphasizes the underlying trimmed and median core rates, expressing concern about the lack of progress. The trimmed mean has been fluctuating between 3.6% and 3.9%, while the median core rate has been 3.8%-4.1%. Secondly, a few hours later, the Canadian government will present its fall economic update. While not necessarily market-sensitive, the Bank of Canada recently suggested that fiscal policies at both the federal and provincial levels may be contributing to inflation challenges. Third, at the week’s end, Canada reports September retail sales. Consumption slowed sharply in Q3, rising only 0.2% (seasonally adjusted annual rate) after a robust 4.7% in Q2. August’s 0.1% decline in retail sales likely overstated the case, and a small gain is expected.
The Canadian dollar showed relative weakness among the G10 currencies last week, gaining around 0.6%. In a soft US dollar environment, the Canadian dollar tends to lag, yet there are signs that the greenback may be forming a topping pattern against the Canadian dollar. To validate this hypothesis, the US dollar needs to stay below the CAD1.38 area. Momentum indicators are trending lower, with the five-day moving average (~CAD1.3730) below the 20-day moving average (CAD1.3770). Ideally, it should close below CAD1.3675 by the end of the upcoming week.