by Marc Chandler
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The most important outcome of the last week's flurry of central bank meetings was the median forecast of Fed officials for 50 bp less in cuts next year than it had anticipated in June as it revised up its growth forecasts for this year and next. The prospect for higher rates for pushed equities lower. Sterling and the Swiss franc were the weakest currencies in the G10 last week, falling by a little more than 1.1%. Both central banks did not hike rates to the surprise of many. Norway more than Sweden held out the possibility of another hike in Q4, while the Riksbank's decision hedge a quarter of its reserves, which seems like intervention, failed to give krona much of a boost, rising about 0.25% against the euro. The Bank of Canada stood pat earlier this month, but stronger economic data saw a nearly doubling to the perceived odds of a Bank of Canada rate hike next month to a little less than 50%.
Japanese officials are threatening intervention but the "higher for longer" signal by the Federal Reserve and the rise in US 10-year yields suggests the yen's weakness is fundamentally driven. Federal Reserve Chair Powell said at least a half-of-a-dozen times the press conference "proceed carefully" but this applies to Japan, as well. If intervention requires the sales of Treasuries (last September and October, Japan's holdings of Treasuries fell by about $130 bln) that could push up US interest rates, which could encourage others to buy dollars. One takeaway from last year's experience is to intervene when one believes US rates are near a high. Higher US rates make some carry trades more attractive, and this adds the weight on the Chinese yuan. The impact of the numerous measures that have been announced are likely to begin percolating and the September PMI may reflect it. The base effect warns of a sharp drop in the eurozone's September CPI due on September 29. Tokyo's September headline and core CPI measures are expected to continue to soften. In the US, the CPI has already delivered the inflation signal, the headline ticked up, but the core likely softened.
United States: We are in between the FOMC meeting and the next employment report. The deceleration of the labor market is expected be continuing and the early estimates are coming in around 150k (vs. 187k in August). If true, it would the second-lowest nonfarm payroll growth since the start of 2021 but could be consistent with a tick lower in the unemployment rate. The market will look past the distortions caused by the labor strikes. In the week ahead, house prices, new home sales (both are expected to have softened) and durable goods orders (second consecutive decline is expected) will be reported. Without the decline in transportation orders (see Boeing), a small increase is possible, may draw some attention. But the main interest will be on the personal income and consumption data. The rise in personal income may have doubled from the 0.2% increase in July. The 0.4% gain would match this year's average through July, the same as the first seven months of 2022. Consumption is likely to have downshifted. After increasing by 0.8% in July, the most since January, the median forecast is for a 0.5% increase, which is still strong. This year's monthly average through July is 0.6%, slightly off last year's pace. Consumption expenditures have been outstripping income, which is translated into lower savings but that may have changed a little in August.
Although the Fed targets the headline PCE deflator, the CPI is stealing most of its thunder. The headline deflator is seen rising by 0.4% for a 3.4% year-over-year increase (from 3.3%). The core deflator is projected to have increased by 0.2%. That would allow the year-over-year rate to ease to 3.8%-3.9%, which would be the lowest since Q3 21. The way that officials could signal a desire to look past the impact of higher energy prices, which acts as a tax consumption, would be to focus even more on the core rate. Meanwhile, time is running out for the US Congress to pass the appropriations bills or there will be a partial government shutdown. This coupled with the (broadening) UAW strike, the resumption of student debt servicing, the higher energy prices, and the tightening of lending conditions set the stage for a significant economic slowdown in Q4.
The Dollar Index is near the year's high set in March near 105.90. It looks poised to take it out, which would target the 107.20 area, the (50%) retracement of the decline since last September's multiyear high around 114.75. The momentum indicators are stretched, which is hardly surprising given that the Dollar Index has risen for 10 consecutive weeks. Still, the five- and 20-day moving average are still moving higher. Last week's low, set prior to the FOMC decision was almost 104.65. It may take a close below there to signal an end of this run-up. Initial support may be seen in the 105.20-30 area.
China: In an unusual calendar twist, China's Caixin PMI will be released before the official one (September 29 vs. September 30). Still, the sequence is not so important and the composites (51.7 vs. 51.3 for the Caixin and official measures, respectively, in July). It seems quite fashionable in the Anglo-American press to frame China's economic challenges in structural terms. And indeed, there does seem to be some structural elements. However, market participants seem to often emphasize structural drivers and under-estimate cyclical forces. Beijing may not be addressing its structural challenges (at the risk of oversimplifying, over-reliance on debt-fueled infrastructure investment and real estate), but it seeking to boost cyclical growth through various channels. These include lower rates, credit easing, encouraging more spending by local governments, allowing re-negotiations of existing mortgages, and lower down payment requirements.
Chinese officials have been able to moderate the yuan's decline. Here in Q3, it is off by about 0.6%, which is less than all the G10 currencies but the Norwegian krone, and all but a handful of emerging market currencies. Still, while the policy divergence is large and the dollar is remains broadly stronger, Beijing faces an uphill battle. The dollar settled on weekly basis this year only once CNY7.30, and it was narrowly averted last week (CNY7.2990). The JP Morgan Emerging Market Currency Index is off nearly 3.5% this quarter. Note that Chinese markets are closed for national holidays for the first week in October.
Eurozone: Some hawks at the European Central Bank want the markets to still believe that the tightening cycle is not over but the market is having little to do with it. The swaps market has a little more than a 20% chance of a hike discounted in Q4 and begins showing a bias toward a cut in Q2 24. It is fully discounted in early Q3 24. The most important data point before the end of the month is the preliminary September CPI. It and October report will likely make the case by the hawk even less tenable. In September 2022, the eurozone's CPI rose by 1.2% (and 1.5% October). These drop out of the 12-month comparisons, and this is going to produce a sharp deceleration in the year-over-year rate. August's 5.3% pace could fall below 4%, and possibly a little above 3.5% before firming in November and December.
The euro has found a (temporary?) foothold above $1.0610, which corresponds to the (38.2%) retracement of the rally from the September 2022 low near $0.9535. A break could spur a return the March low around $1.0500 and the year's low set in January, a little lower (~$1.0485). The euro has fallen for 10 consecutive weeks since the mid-July peak of about $1.1275. The single currency has not traded above the 20-day moving average this month. It is found now slightly below $1.0740.
Japan: Even though Japan reports on the labor market, retail sales, and industrial output, it may be difficult to convince the market that the world's third-largest economy is not contracting in Q3. Japan's retail sales are not a good gauge of consumption. Consider that in July household spending fell 5.0% year-over-year (-4.2% in June), while retail sales rose 6.8% (5.6% in June). Retail sales are reported in nominal terms (value not volume) and focus on retail goods. The broader measure of household spending includes services and is in real terms (adjusted for inflation). The Bank of Japan left policy on hold last week and Governor Ueda seemed to dampen hope that he had inspired about an exit from negative interest rates before the end of the year.
The key data point next week is Tokyo's September CPI. Like the CPI gives valuable insight into the US PCE deflator, Tokyo's CPI is a good gauge of the national measure that is reported a few weeks later. While the headline and core rates have peaked, the risk is still on the upside with the measure that exclude fresh food and energy. In the three months through August, the headline rate has risen at 2.4% annualized rate and the core by 2.8%. However, excluding fresh food and energy rose at 4% annualized pace. In August, Tokyo reported that fresh food prices had risen by 4% year-over-year and food prices in general were up 8.2%. Next week, Prime Minister Kishida is expected to begin providing details of the priorities of the supplemental budget that will likely be formally announced next week. Lastly, early on October 1, the Q3 Tankan Survey will be released. A small improvement in sentiment among the large companies is expected while response from small businesses is likely to remain poor (in slightly negative territory).
Japanese officials have been threating intervention for several weeks in the face of the 1) the broad dollar rally and 2) rising US interest rates. The falling yen is not as supportive for Japanese equities, and in the week ending September 15, foreign investors sold the most Japanese shares in four years. The rolling 30-day correlation has turned negative, which, while not precedented, of course, is not the usual relationship. The market is cautious, but it is pushing ahead. The weekly close above JPY148 was the highest since last October. The greenback has risen for three consecutive weeks against the yen and seven of the past eight weeks. It closed firmly near JPY148.40. The secondary high after last year's peak was near JPY148.85, and after that, there is little in front of the psychologically important JPY150.
UK: It is a relatively light week for high-frequency market moving data from the UK. Nationwide's house price index and lending (and mortgage figures), money supply, and consumer credit typically have negligible impact. Revisions to Q2 GDP (0.2% quarter-over-quarter) have been superseded by the recent news that the economy contracted by 0.5% in July. It is, though, the one-year anniversary of the crisis that led to the end of Truss's short tenure as prime minister and sterling's record-low (~$1.0350, September 26). Since then, sterling is the strongest of the G10 currencies, net-net appreciating almost 16% (the euro is in second with about an 11.3% gain). Recall Truss was pushing for tax cuts and increased defense spending that would have left a GBP60 bln deficit by the middle of the decade, according to the Financial Times estimates. Interest rates surged on the prospect the large unfunded deficits. Capital went on strike. Truss was toppled by her own party and fiscal orthodoxy was supposed to return. Yet, the budget deficit for the fiscal year that ended in March was about GBP120.7 bln, up from GBP112.1 bln in the previous fiscal year. The deficit in first four months of the current fiscal year is around GBP53.3 bln compared with almost GBP39.7 bln in the April-July period last year.
Sterling held below the 200-day moving average ($1.2435) last Monday and Tuesday, before the week's big events. It was offered after the FOMC meeting and fell to almost $1.2430. It was tagged for the better part of a cent on the BOE's decision to hold rates and saw a low $1.2240. It made a marginal new low, slightly above $1.2230 ahead of the weekend and sterling closed near its lows. While there may be support around $1.2200, the larger head and shoulders pattern, which we have been tracking, has an objective near $1.20, and the (38.2%) retracement is around $1.2075.
Canada: The market extended the Canadian dollar's decline after it was unannounced that unexpectedly Canada's GDP contracted in Q2 (-0.2%) on September 1. However, the data since then suggests it was a bit of a fluke that overstated the weakness of the Canadian economy. The August employment report was stronger than expected and aggregate hours worked increased. The IVEY PMI snapped a four-month decline in August to match its best level since April (53.5). The July trade deficit was smaller than expected (CAD990 mln). July retail sales rose by 0.3% after a rising by 0.1% in both May and June. Excluding autos, retail sales rose 1.0%, twice the median forecast in Bloomberg' survey. August CPI surprised on the upside, rising by 0.4% on the month (also, twice the median forecast in Bloomberg's survey) and the year-over-year rate rose to 4.0% from 3.3% in July. The underlying core measures and their three-month moving average, which Bank of Canada Governor Macklem referenced, rose as well. The highlight in the coming week is the July monthly GDP. After contracting by 0.2% in June, the Canadian economy likely grew again in July. The takeaway is that swaps market has moved to discount a little more than an 70% chance of a hike in Q4, with a little less than a 50% chance it is delivered next month.
This adjustment in rate expectations dovetails with the recent recovery in the Canadian dollar. The Canadian dollar rose for the third week in the past four, following a six-week slump. So far, this month, the Canadian dollar's nearly 0.20% gain leads the G10 currencies. After peaking near CAD1.3700 on September 7, the US dollar was sold to almost CAD1.3380 the day before the FOMC meeting concluded. It subsequently bounced to CAD1.3525, a little shy of the (50%) retracement of the leg down, before returning to CAD1.3425 after Canada's retail sales report ahead of the weekend. Still, the greenback recovered to make new session highs near CAD1.3500. The close, though was little changed near CAD1.3480. There appears to be scope into the CAD1.3550-75 area.
Australia: Australia reports the August monthly CPI and retail sales ahead of the central bank meeting on October 3. It will be the first policy meeting under the new Governor Michele Bullock. The monthly CPI peaked at the end of last year at 8.4% and it stood at 4.9% in July. The downtrend is expected to have continued in August. July retail sales were boosted by the FIFA Women's World Cup and likely fell in August. Elsewhere, we note that the labor dispute at Chevron's liquified natural gas plants has been resolved. Rising mortgage rates are being felt as three-year fixed rates are beginning to float with a large switch seen this month. The market sees practically no chance of a hike at Bullock's first meeting but is not convinced that the RBA is finished and sees a window of opportunity for the last hike in the cycle to be delivered in Q1 24. The Australian dollar has forged a range between around $0.6360 and $0.6525. The range was nearly covered Wednesday-Thursday last week (~$0.6385-$0.6510). Expect the range to hold, until it doesn't. Unlike in the euro and sterling, the next speculative position in the futures market, is net short the Aussie., which changes the potential dynamics.
Mexico: Mexico reports the August trade and employment figures next week ahead of the central bank meeting on September 28. Many argue that the peso's rally to its best levels since 2015 is producing an overvalued currency. Yet, the richness of the peso is not fueling a deterioration of the external balance. Through July, Mexico has reported a trade deficit of $7.22 bln. In the first seven months of 2022, the trade deficit was slightly more than $19 bln. Moreover, leaving aside portfolio and direct investment inflows, worker remittances alone are sufficient to cover the trade deficit. In the January through July period, worker remittances into Mexico are nearly $36 bln, almost a 10% increase from the same period a year ago. Mexico's unemployment rate appears to have put in a cyclical low near 2.4% in March. In July it was slightly above 3.1%. Last year, it averaged almost 3.3%. Banxico has indicated it is on hold for a protracted period. Brazil and Chile have cut rates twice as they begin their easing cycle. The first cut by Banxico has been pushed from Q4 23 to Q1 24, according to the swaps market.
The US dollar traded briefly below MXN17.0 before the FOMC meeting concluded and rallied to MXN17.25 the following day. Sellers pounced on the greenback sending it back to MXN17.10. However, the risk-off mood that prevailed before the weekend helped lift the dollar, which settled near MXN17.2200. Early last week the five-day moving average crossed back below the 20-day moving average. The macro forces that have driven the peso almost 14% higher this year against the dollar appear to remain intact. Also, as Brazil, Chile, and other countries in the region cut interest rates, Mexico's yields become relatively more attractive. Consider, for example, at the start of the year, Chile's overnight rate was 75 bp more than Mexico and now it is 175 bp below. Still, a move above MXN17.27 could see MXN17.35-45.
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