by Marc Chandler
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The week ahead is important from a macro perspective. The data highlights include China's PMI, eurozone preliminary October CPI and Q3 GDP, and the US (and Canadian) employment reports. In addition, the Federal Reserve meeting on November 2 is sandwiched between the Reserve Bank of Australia meeting and the Bank of England meeting.
Let us preview the data before turning to the central banks. Yet the challenge with the data is that the underlying macro views are unlikely to change. Central banks say that policy will be data-driven, but it begs the question of what data and how it fits with the forward guidance.
This seems to be less the case in China. The October PMI will be reported before the markets open on Monday. The US, eurozone, and UK preliminary October PMIs were below the 50 boom/bust level, yet the ECB hiked last week, and the Fed and BOE will hike in the coming days. China's composite PMI was at 50.9 in September. The unpredictable Covid-related restrictions continue to plague the economy, which also suffers from weak consumption and the collapse of the property sector. The US latest sanctions in the semiconductor industry are a significant escalation of US efforts to contain China's development. The full ramifications will take some time to sort out, but this is important.
The eurozone reports its preliminary October CPI figures and its first estimate of Q3 GDP. The euro was little changed to slightly firmer in October. Energy was mixed. Brent oil snapped a four-month drop and gained about 9.4% in October. The Dutch benchmark for natural gas fell around a third. While that sounds helpful, these are wholesale prices, not retail. National harmonized figures from Germany, France, Italy, and Spain surprised on the upside. After a 1.2% surge in eurozone September CPI, a 0.7%-0.9% rise in the aggregate measure is likely and it will keep the year-over-year rate around 10%. The core rate may prove sticker. It may have reached a new cyclical high, approaching 5%.
With some national figures released before the weekend, it now looks as if the eurozone's economy may have expanded by 0.1%-0.2%. At best, it looks like a transition quarter between the expansion and the coming contraction. Most economists see the contraction beginning in Q4 and carrying into next year. It is clear, though, that a mild recession is not going to prevent the ECB from normalizing monetary policy. Last week's 75 bp hike lifted the deposit rate to 1.50%. The market envisions at least a 50 bp increase at the mid-December meeting and a terminal rate of about 2.75%.
As of the middle of October, the ECB's balance sheet stood at nearly 8.8 trillion euros. During the Great Financial Crisis and the pandemic, bond purchases were the common way central banks expanded their balance sheets. However, about a quarter of the ECB's balance sheet is accounted for by loans. A little more than half of those loans (1.2 trillion euros) are due in the middle of next year. The changes the ECB announced last week will likely encourage early repayments. Therefore, in addition to the interest rate hikes, even if the ECB carries on recycling the maturing proceeds of its holdings, its balance sheet is poised to fall sharply around the time it reaches what is now expected to be the terminal rate.
The end of the week features the October US employment report. Job growth is gradually slowing. The median forecast is for the private sector may have filled slightly less than 200k jobs. That would be the least of the year and bring the three-month average below 300k. Still, it needs some context. Consider that in 2018-2019, the private sector added, on average, about 150k jobs a month. The participation rate had bounced between 62.1% to 62.4% this year compared with 63.3%-63.4% in the three months before Covid struck. At the same time, the unemployment rate has been between 3.5% and 3.7% since the 3.8%-4.0% readings in January and February.
Hourly earnings are expected to have risen by 0.3% for the third consecutive month in October. In October 2021, average hourly earnings rose by 0.6%. The base effect would see the year-over-year rate slow below 5% for the first time since September 2021. Looking ahead, the base effect will make favorable comparisons over the next three months. This dovetails nicely into ideas that the Fed will moderate the pace of hikes after this week's three-quarter-point move.
Which is a nice segue from the market-sensitive macro data to the central bank meetings. The key issue for the markets is not about the fourth consecutive 75 bp hike, which puts the upper end of the target range at 4.0%. That is as done of a deal as these things get. Rather, it is about the Fed's signal of its intentions. The market sees a terminal rate near 5.0%. The futures market has about a 50% chance of another 75 bp hike in December, but the conviction seems soft as the idea of calibrating the pace has apparently gained momentum. Of course, it is data dependent, a mantra that has been repeated enough times that it is devoid of much substance.
Given the base effect, the lagged impact of the tightening of financial conditions, dollar strength, and recent price trends, CPI, the key data point, is likely to slow markedly in the coming quarters, beginning this month. This will provide a favorable backdrop for slowing the tightening pace. Moreover, despite concerns expressed by Treasury Secretary Yellen about bond market liquidity, the Fed will most likely reaffirm the current effort to unwind the balance sheet ($95 bln a month). That said, many observers do not think the Fed is yet on a sustainable course. Some banks are already warning that the balance sheet roll-off will end toward the middle of next year as the system needs more reserves, while others, like Harald Malmgren, a senior White House adviser from Kennedy through Ford, see the Fed eschewing the 2% inflation target and adopting a 3%-4% target.
There have been six FOMC meetings this year. The Dollar Index rose on the day of the first (January 26), and the last (September 21), while falling on the other four. But if there is a meaningful pattern, it is as obvious as it may seem. Sometimes the dollar rallied the day before and sometimes the day after. And two out of six is still close enough to 50/50 as not to be a solid basis for a trading strategy. Also, the two-year note yield has risen on three of the meeting days and fallen on the other three.
The Reserve Bank of Australia's decision will be announced early on November 1. Even though CPI accelerated more than expected in Q3 (7.3% vs. 6.1% in Q2), the market is still comfortable with a quarter-point hike. Recall that the RBA began its normalization cycle in May with a 25 bp hike. It then proceeded to deliver four half-point moves through September. Finally, it slowed the pace back to 25 bp in October, lifting the cash target rate to 2.60%. The futures market sees the RBA hiking through most of the first half of next year with a terminal rate near 4%.
Without being too concerned about the precise definition, Australia is seen to be the least likely, according to Bloomberg surveys, to fall into a recession over the next 12 months. The median result saw a 25% chance. That is half the odds for its neighbor New Zealand and a little less than the 30% chance of a recession in Japan. The risk of a recession in the US is put at 60%, 80% in the UK, and 90% in Germany. The risk of a recession in France is the same as in the US. Canada is among the lowest at 45%.
The Bank of England meets on November 3, the day after the FOMC meeting concludes. In a savvy move, Prime Minister Sunak delayed the fiscal statement that was scheduled for October 31 to November 17. This will allow the Office for Budget Responsibility to consider the sharp drop in UK interest rates over the past couple of weeks that unwound most of the spike. Some estimates suggest that using the updated rates could reduce the funding gap by as much as GBP15 bln.
Even though the details of the fiscal program will not be announced before the BOE meeting, the unambiguous signal is for an austere budget, the opposite of Truss's spending and tax cuts. Amid the market turmoil in late September and threats by the Bank of England for drastic action, the swaps market discounted a 150 bp hike. However, as the unfunded fiscal stimulus was retracted and financial orthodoxy took hold, the market has scaled back expectations. The swap market settled last week with roughly split between a 50 bp and 75 bp move. A three-quarters point move would lift the base rate to 3.0%. The swaps market sees the peak coming in Q2 23 near 4.75% in Q2 23.
The UK's two-year yield was around 3% before the market chaos. It reached nearly 4.75% in late September and fell to about 3.10% last week before bouncing into the weekend. The long end of the curve, where BOE's bond-buying efforts focused on stabilizing the market, had seen the 30-year yield rise above 5% on October 12. Last week, the yield slipped to 3.45%. It also recovered a head of the weekend. 3.60%. It was near 3.50% in mid-September. For its part, sterling has also recovered smartly. It had fallen to $1.0350 (according to Bloomberg) in late September, a record low, and pushed to almost $1.1650 last week. It found support near $1.1500 ahead of the weekend, amid a broad dollar recovery. The euro spiked above GBP0.9250 in the late September chaos, but by the end of the week, it had returned to the GBP0.8600 area, where it was before the turmoil.
Let us turn to the individual currency pairs.
Dollar Index: The five-session pullback ended on October 27, helped by a dovish read of the ECB. However, even after the higher-than-expected inflation readings by Germany, France, and Italy, and the dramatic rise in rates, the Dollar Index extend its recovery ahead of the weekend. We envisioned that after the ECB and BOJ meetings, the focus would shift back to the US ahead of the FOMC meeting and the employment data. This would allow the Dollar Index to extend its recovery. The MACD looks poised to turn higher, while the Slow Stochastic has a little bit more work. Scope on the upside may extend into the 111.75-112.25 area The trendline off the mid-August, mid-September and early October lows was taken out on October 25. At the end of next week, it comes in near 112.70. Resurfacing about it would lift the technical tone.
Euro: The euro's recovery from the two-decade low in late September near $0.9535 may have ended with its approach to nearly $1.01 before last week's ECB meeting. Corrective forces pushed the euro to a three-day low ahead of the weekend near $0.9925. The MACD is looking toppish. The Slow Stochastic is still moving higher but is becoming stretched. Initial support is around $0.9880 and then $0.9840. On the upside, a move back above parity lifts the tone and seems consistent with the forging of a potentially important low. The initial dovish read of ECB President Lagarde was reassessed in light of the acceleration of inflation in the preliminary October reports.
Japanese Yen: The dollar held above JPY145 last week. Tactically, this level needs to be broken if Japanese officials are going to inflict pain on the dollar bulls. The traditional LDP policy prescription of easy money and fiscal accommodation was underscored by the BOJ, which is continuing to expand its balance sheet, and Prime Minister Kishida's new spending and subsidy bill. However, the key to the exchange rate still seems to be US rates. The BOJ does not have to overcome the trilemma that the consensus narrative seems to believe. It just needs to buy time until US interest rates peak. The first technical hurdle is seen near JPY148.50 and a break of it signals another run at JPY150. The momentum indicators are still falling as the nearly seven-yen decline beginning from the high on October 21 is still being detected. The BOJ intervention in late September for almost $20 bln took place the day after the Fed's last hike.
British Pound: Sterling was easily the best performing G10 currency last week, appreciating by 2.75%. It was the third consecutive weekly gain. It finished the week firmly above$1.16 after nearing $1.1640 in the middle of last week, which corresponds to almost the (38.2%) retracement objective of this year's decline. The momentum indicators are stretched but there is scope for additional even if modest gains in the coming days. That said, the $1.1740-50 area may be sufficiently formidable to keep stronger gains in check given the over-extended indicators. The $1.1500 area, which had been resistance previously, may now be support. With a heavy dose of fiscal austerity about to be delivered, the Bank of England may hike the base rate by only 50 bp, as it did in August and September rather than deliver on its threat of a more dramatic move in the face of Truss/Kwarteng's fiscal stimulus.
Canadian Dollar: The US dollar extended its pullback after approaching CAD1.40 in late September. It made a new marginal low for the month on October 27, slightly below CAD1.3500. The momentum indicators are still falling, but the resilience of the greenback in the face of the pre-week stock market rally hints of what may be in store. The US dollar can move into the CAD1.3675-CAD1.3720 area without improving the underlying technical condition. However, gains through CAD1.3850 negative the topping pattern that seems in the process of being forged. A break of CAD1.3500 would lend credence to it and suggest a medium-term target near CAD1.30, which is where the exchange was in mid-September.
Australian Dollar: After setting a two-and-a-half-year low on October 13 near $0.6170, the Australian dollar rallied almost 6% to poke above $0.6520 on October 27. The demand faded and the Aussie gave back some of its recent gains. It fell briefly through $0.6390 ahead of the weekend to meet the (38.2%) retracement of the rally since October 13. The MACD and Slow Stochastic are still trending higher, but if the corrective/consolidative phase has begun, the Aussie can test $0.6350-65, and possibly $0.6300. A quarter-point hike from the Reserve Bank of Australia on November 1 will not be as surprising as it was on October 4.
Mexican Peso: The peso's resilience continues to impress. Since around mid-August, the greenback has been mostly trading between MXN19.80 and MXN20.20. It finished last week slightly below MXN19.80, for the first time since early June. Last month, on an intraday basis, it reached almost MN19.75. A break of that area could spur a move toward the MXN19.60 area. The momentum indicators do not appear to be generating a useful signal. However, the US dollar finished the week below the lower Bollinger Band (~MXN19.82). The implied three-month volatility, around 11.4%, is lower than for most G10 currencies. It has not been below 11% for six months. The central bank does not meet until November 10 and is expected to match the Fed's move. Separately, the US dollar firmed to the upper end of the three-month trading range against the Brazilian real ahead of the weekend run-off. An uncontested outcome could see move unwind. It traded a little above BRL5.38 before the weekend. The 20-day moving average (~BRL5.26) is round the middle of the recent range.
Chinese Yuan: The yuan initially was sold dramatically after the 20th Party Congress ended and the dollar reached nearly CNY7.31 on October 25. Dollar sales by state-own banks onshore and offshore were reported the following day, and there are suspicions that the People's Bank of China may have intervened directly. Some link the possible Chinese action with apparent Bank of Japan intervention in an uncoordinated move but ostensibly to boost the chances of success. In any event, after managing to drive the greenback to about CNY7.1635, the dollar bounced back and finished the week above CNY7.25. According to the BIS triennial survey, the yuan's share of the $7.5 trillion average daily turnover in the foreign exchange market is 7% (up from 4% in 2019). This amounts to around $525 bln a day. Consider that it has recorded a trade surplus of roughly $645 bln in the first nine months of the year. Not only China, but nearly every country that runs a trade surplus and has not pegged their currency to the dollar has experienced depreciation. Capital flows now typically swamp trade flows. Globally, the BIS estimates, average daily foreign exchange turnover is $7.5 trillion. Annual global trade was nearly $29 trillion in 2021, and the world's GDP last year was about $96 trillion. While different tactics are being pursued, China, like Japan and other East Asian countries are trying to moderate the pace that its currency is depreciating.
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