by Marc Chandler
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The week ahead has a relatively light economic schedule, punctuated by the US Thanksgiving Day holiday on November 24. Nevertheless, the data highlights include the preliminary November PMIs, Tokyo's November CPI, and the FOMC minutes from this month's meeting.
The data is not the driver now; psychology is. The precise print, for example, of the eurozone and the UK's preliminary PMI will likely be of little consequence. The composite has fallen for six consecutive months through October. It has not been above the 50 boom/bust level since June. The issue is not really if the eurozone is going to escape a contraction but rather its depth and duration. The UK's composite PMI has fallen since April with one exception (June), and it has been below 50 for three months through October. The British economy contracted by 0.2% in Q3, and the central bank expects it to continue to shrink for several more quarters. That must be the base case unless proven wrong.
Australia's October composite PMI slipped slightly below 50 (49.8) for the first time since January, when it was a false negative (December 2021, 54.9; February 2022, 56.6). Australia's economy seems to be slowing gradually, but it is not contracting. Interestingly, both the median in Bloomberg's survey and the Reserve Bank of Australia's central bank's forecast is for this year's 4% growth to slow to 2% next year. Australia reported the strongest quarterly (Q3) wage growth in a decade (3.1%) and employment growth in October that was twice as high as expected (32.2k).
Nevertheless, the swaps market is not sure that the Reserve Bank of Australia will hike the cash rate when it meets on December 6. The market has priced in about a two-third chance. We suspect it will move by a quarter of a point. On the other hand, the Reserve Bank of New Zealand meets on November 23. It has lifted rates at every meeting beginning October 2021. The first three moves were 25 bp, and the last five have been half-point moves. The swaps market is nearly evenly split between 50 bp and 75 bp. Almost two-thirds of the economists surveyed by Bloomberg call for a 75 move.
The first official estimate had the Japanese economy unexpectedly contracting in Q3 by 1.2% at an annualized rate. The only hint from the composite PMI in Q3 was the sub-50 reading in August (49.4). During August, Japan experienced a spike in Covid. Some weakness may be revised away when capital spending data is available. Capex in Q3 rose 1.5% quarter-over-quarter rather than the 2.2% of the median forecast in Bloomberg's survey. Primed by $260 bln stimulus measures, the Japanese economy already appears to be snapping back. Japanese inflation is accelerating. October headline inflation rose to 3.7% year-over-year, and the core rate (excluding fresh food) to 3.6%. Both were at 3.0% in September. The headline rate rose 0.6% in October alone, the same as August and September combined. Tokyo's November CPI will be released on November 25, providing helpful insight into the national figures. It is expected to have edged higher. Still, the BOJ expects price pressures to subside next year and fall below 2%, and importantly, the market agrees.
While the Atlanta Fed's GDPNow sees the US economy tracking 4.2% this quarter, the composite PMI was below 50 throughout Q3 and the beginning of Q4 (48.2 in October). Regardless of the PMI print, the market thinks it knows two things. First, the Fed's September dot plot (Summary of Economic Projections) had the median expectation for 125 bp hike in Q4. The down payment was made earlier this month was a 75 bp hike. Even after the softer-than-expected CPI and PPI, the market remains confident that the remainder will be delivered in December. Second, the market is convinced the US economy is slowing. The weight of tightening monetary and fiscal policies, the squeeze from higher food and energy prices, and the historically over-valued dollar are proving too much. The median forecasts for Q1 23 and Q2 23 Bloomberg's survey envision a slight contraction. The year-over-year activity in Q3 23 and Q4 23 is expected to be practically stagnant.
Two calendar spreads in the Fed funds futures are particularly worth monitoring. The first is the spread between the March and June contracts. This helps fine-tune where and when it is now expected to reach the terminal rate. The softer the expected inflation reports have helped the market returned to their pre-FOMC answer for where the funds rate will peak. 4.75%-5.0% with a bias toward the upper end of that range. The June 2023 Fed funds futures contract yields about 16 bp more than the March contract. One way to express this is that the market has almost a 2/3 chance of a hike in Q2.
The second is the spread between the September and December contracts. For around eight months, the yield on the December contract has been below the September yield. Since July, the market has been fickle. There are times when the December contract has approached a 25 bp discount to September, meaning that a cut is priced into the market, only to have second thoughts, sometimes encouraged by hawkish Fed comments or an inflation report that missed expectations. The market appears to have made a significant break after the recent inflation data. The yield implied by the December contract is more than 30 bp below the September contract. This is consistent with high confidence that the Fed will cut rates by at least a quarter of a point toward the end of next year.
Let us turn to the dollar's price action itself. After the big pullback after the CPI and what some think was a pivot in China's Covid stance, which officials denied even though it seemed to have been shrugged off, we anticipated a bounce in the greenback. It did not really occur. Even after the "missile" strike on Poland, sellers emerge into the dollar rally that speaks of a market that is long. So, we want to pay particular attention to levels that, if violated, would suggest a corrective rather than a consolidative phase, which remains our preferred view. At the same time, we want to be aware of the next challenges if the dollar setback and foreign currency rally extend further.
Dollar Index: The move that we think needs to be corrected is the slide since the November 10 lower-than-expected US CPI. The Dollar Index has held below the minimum retracement (38.2%), found at 107.50. The momentum indicators are over-extended and appear poised to turn higher. A break of 107.50 can spur a move toward 108.15 and possibly toward 109.00. This higher level seems more reasonable to us, which also corresponds to the (38.2%) of the larger decline since the late September peak, slightly above 114.75. Last week's low was about 105.35. The 200-day moving average is closer to 105.00. It has not been below this moving average since June 2021.
Euro: For its part, the euro is knocking on its 200-day moving average (~$1.0415) and traded above it on an intraday basis a couple of times last week, which is also the first time since June 2021. However, it was unable to close above it. The momentum indicators appear poised to turn down in the coming days. The (38.2%) retracement of the rally since the US CPI is near $1.0270. The (50%) retracement is closer to $1.02, which also corresponds to the (38.2%) retracement of this month's gains. Given that the speculators (non-commercials) in the futures market have their largest net long euro position since mid-2021 (113k contracts), the euro's downside potential could extend toward $1.01. On the upside, the $1.05-$1.06 area may offer the next significant hurdle.
Japanese Yen: The dollar straddled the JPY140 level last week. It cost the MOF billions of dollars in September and October, but they bought sufficient time for the US yields to come off. In fact, the correlation between changes in the exchange rate and the US 10-year yield rose to nearly its highest level of the year at the end of last week on a 30-day rolling basis (0.70). The Slow Stochastic appears to be turning up from oversold territory, and the MACD looks poised to do so. Initial resistance is in the JPY140.80-JPY141.00 area. We suspect the greenback can recover into the JPY142-JPY143 area. That said, a push below last week's low (JPY137.70) runs the risk of dollar losses toward JPY135.
British Pound: Sterling poked above $1.20 for the first time since August last week. It did not settle above it but also held above the low recorded on that day in the subsequent three sessions ($1.1740). To appreciate the magnitude of sterling's bounce since the end of September's record low, note that $1.2050 is the (50%) retracement of this year's losses since the mid-January higher near $1.3750. The 200-day moving average is around $1.2225, and sterling has not traded above it since mid-January. The momentum indicators are stretched, but a marginal new high cannot be ruled out. On the downside, we suspect a break of $1.1700 is needed to be anything important.
Canadian Dollar: We have been tracking a head and shoulders topping pattern in the Canadian dollar. The greenback broke through the neckline at CAD1.35, which projects to CAD1.30. A base has been forged around CAD1.3225 in recent days, a little more than halfway to the objective. The US dollar's bounce carried it back to CAD1.34, which is the (50%) retracement of the loss since the November 10 US CPI. The next resistance area is likely around CAD1.3450, while a move above CAD1.35, which is also around where the 20-day moving average is found, would be disappointing. That said, the momentum indicators are curling up from oversold territory, and risk is on the upside.
Australian Dollar: The Aussie bottomed on October 13 near $0.6170 and reached nearly $0.6800 in the middle of November. The momentum indicators reached their highest levels in around four months. They have not turned down but look set to in the coming sessions. The pullback to $0.6640 on November 17 met the (38.2%) retracement objective of the rally since the US CPI, but there is potential into the $0.6550-$0.6600 area. We suspect it could fall toward $0.6500, especially if the market's doubts about a rate hike next month grow. On the upside, there is little resistance on a break of $0.6800 before $0.6900.
Mexican Peso: The dollar fell to a marginal new low since March 2020 last week (~MXN19.2510) but resurfaced above MXN20.50 at the end of the week. The greenback can retest the MXN20.60 area, the (38.2%) retracement of the losses since the October high (~MXN20.1750), and the 20-day moving average (MXN20.61). The momentum indicators have turned higher. Above the MXN20.60 area, the next hurdle is around MXN19.70, and the MXN19.80 area marks the bottom of the old congestion band. Speculators in the futures market are net long the most peso futures contracts since March 2020 (~67.9k) after being next short (41k), the most since the end of last year in late September. With the stalling of the peso's upside momentum, these late longs seem vulnerable.
Chinese Yuan: The dollar peaked on November 1 near CNY7.3275. Last week, it recorded a low around CNY7.0250. While there is hope that despite the highest levels of Covid infection for months, China is moving away from its strict zero-Covid policy. There is also hope that the new measures for the property market will be successful and that the deterioration of its relations with the US (and Europe) has been arrested. Our work also shows that the yuan's correlation with the euro and yen is the highest in years. The dollar quickly retraced half of the month's losses (~CNY7.1760). Without deciphering Beijing's intentions, our bias is a stronger dollar. Still, the PBOC warning about price pressures likely to rise with the recovery warns that it may not want to see a much weaker yuan.
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