by Marc Chandler
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The US dollar was mixed last week. One would have thought, based on the geopolitical tensions, the stronger than expected US economic data that resulted in upward revisions to Q3 GDP forecasts and a more than 30 bp surge in US 10-year yields, the greenback would have performed better. The Dollar Index fell by almomst 0.5% last week, its biggest weekly loss in three months. It is down so far this month. On the other hand, gold rallied 2.5% to extend its gain to about 8% since the Hamas attack. December WTI's 2% advance brings its surge to about 8.2% in the same period, or about $6.75 a barrel.
The heightened geopolitical uncertainty provides a fragile backdrop for the global capital markets. The market is on guard for possible Bank of Japan intervention directly in the foreign exchange market for the first time since last October. The surge in interest rates was stemmed ahead of the weekend, helped perhaps by the sharp losses in the largest equity markets and the broad risk-off. In addition to these forces shaping the investment climate, three events that highlight the week ahead. First, the ECB meets on October 26. There is practically no chance of a change in policy, but the press conference often elicits a market response. But shortly before President Lagarde's press conference, the US release its first estimate of Q3 GDP. It is expected to be unusually and unsustainably strong, with the median in Bloomberg's survey creeping up to 4.3%, led by strong gains in consumption. Several hours later, and ahead of the weekend, Japan's October Tokyo CPI will be released. The headline is expected to slip slightly lower, but the core rate, which the Bank of Japan targets, may have held steady at 2.5%.
United States: The release of the first estimate of Q3 US GDP on October 26 is the data highlight of the week in the US. Other observers may place more emphasis on the measure of inflation the Fed targets, the PCE deflator, but we think that CPI steals most of its thunder and the personal income and consumption data will be embedded in the GDP estimate. That said, due to different methodologies, the PCE deflator can tick down to 3.4% on the headline year-over-year rate and the core ease to 3.7% from 3.9%. Last September, the headline rate stood at 6.6% and the core was at 5.5%.
Market estimates for Q3 GDP crept higher in recent weeks, and last week's retail sales, industrial output and business inventory reports were all stronger than expected. and the median forecast in Bloomberg's latest survey is for a 4.3% annualized pace. It is still below the Atlanta's Fed GDP tracker of 5.4% but would still be the largest rise in US output since Q4 21. Growth was likely led by the US consumer, who seemed to have retreated in Q2 (0.8% rise at an annualized rate) and went on a spree in Q3 (~3.9%?). Government spending likely slowed to about half the Q2 pace of 3.3% annualized. Private investment is also expected to have slowed to less than 3% from a little above 5% in Q2. Consumption, government spending and private investment are expected to slow here in Q4. October's preliminary PMI may pose headline risk but there is nothing in the composite output figures in recent months, including September 50.2 reading that gave a hint about the strength of US GDP. Indeed, the (output) composite averaged 50.8 in Q3 and 53.6 in Q2. It was below the 50 boom/bust level in Q3 22-Q1 23.
Despite the series of stronger economic data and the rise in US yields, the Dollar Index could not find its mojo and fell for the second time in three weeks. The high for the year was set on October 3 near 107.35, but last week struggled near 106.65. The price action and momentum indicators suggest the downside correction may not be over. The five-day moving average (~106.30) slipped below the 20-day moving average (~106.35) for the first time since late July. Still, a break of the recent lows near 105.50 is needed to bolster the chances that a more durable top is in place.
Eurozone: The European Central Bank meets on October 26. There is practically no chance that it hikes the deposit rate from 4.0% after hiking in September. Although some ECB officials try to convince the market that it might not be done, with poor economic data and softening inflation, the market has not been persuaded. In fact, the swaps market is discounting almost a 90% chance of a hike that the ECB is done. It has almost 2/3 of the first cut discounted by the end of H1 24, which dovetails with Bloomberg's latest monthly survey of economists, where 60% see a cut by the end next June. The flash PMI may draw some attention after the (output) composite snapped a four-month decline in September, rising to 47.2 (from 46.7). It has been below 50 since June's report. Last October, the composite was at 47.3, where it bottomed in 2022.
The euro fell for 11 consecutive weeks through the end of September but has steadied here in October. It has risen in two of the past three weeks but is net-net little changed having settled last month slightly below $1.0575. The momentum indicators are constructive, and the five-day moving average (~$1.0565) has moved above the 20-day moving average (~$1.0555) for the first time since late July. But there seems to be little enthusiasm for the upside and sideways movement could re-set the momentum indicators. A move above $1.0640-50 is needed to reanimate the euro.
Japan: One would not know by looking at Japan's (output) composite PMI that the economy is likely to have contracted in Q3. The quarterly average of the composite has been above the 50 boom/bust level since Q1 22. The three-month average was at 52.3 in September. It averaged 50.2 in the quarter through September 2022. Prime Minister Kishida is putting together a supplemental budget, some of which will be funded from previously authorized but unspent funds. Tax cuts to encourage investment in what are regarded as strategic sectors, like chips, AI, and electric batteries are likely to be included. Tokyo's October CPI is the more important data point. Although the weights are slightly different than the national measure, the Tokyo CPI is a robust proxy. Tokyo's headline CPI peaked in January at 4.4% year-over-year. It had fallen to 2.8% in September. Another small decline looks likely. The core rate, which excludes fresh food, has fallen from 4.3% in January to 2.5% in September. Economists expect it to be unchanged in October. The most stubborn measure excludes fresh food and energy. It peaked in July and August at 4.0% and slipped to 3.9% in September. The median forecast tin Bloomberg's survey is for a decline to 3.7%.
Rather than another adjustment of the upper-end of the JGB band or a change in rates (end of the month meeting), the market is on-guard for unscheduled bond purchases and/or intervention in the foreign exchange market. The dollar could not get closer to the JPY150 level than it did before the weekend (about one ten-thousandth of a cent) away. The combination of speculation that BOJ could defend it in thin trading early Monday, the optionality struck there, the backing off of US rates, and the geopolitical uncertainty headed into the weekend seem to deter operators. Still, when everything is said and done, the dollar remains in the range set on October 3 (~JPY147.45-JPY150.15). One-month implied volatility slipped in the first half of last week, and although it recovered in the last couple of sessions, it finished slightly lower on the week (~8.3%). Actual or historic one-month volatility is near 5.2%, the lowest this year.
China: The economic calendar is lightnext week. This past week's data showed somewhat stronger growth than many expected, but more stimulative measures are likely before the year's over. China's 10-year discount to the US widened to nearly 230 bp last week. It finished last year around 105 bp. China's CSI 300 was among the worst performing large markets last week, falling by more than 4% to bring the year-to-date loss to about 9.3%. The Chinese yuan was slightly softer against the dollar. It has fallen in seven of the ten sessions since returning from the extended holiday. The dollar finished last week near CNY7.3170. Beijing may get some help from Japan if the Bank of Japan intervenes and succeeds in knocking the dollar down. However, we suspect that without improved macro considerations or an escalation of Beijing's efforts, a pullback in the dollar will be bought.
Canada: The softer than expected September CPI last week takes pressure off the central bank at this week's meeting. The swap market was discounting a nearly 43% chance of a hike at this week's meeting on the eve of the CPI report, which was the most in about two-and-a-half weeks. After the CPI, the odds fell to a little less than 15%. The odds of a hike before the end of year (the last meeting of the year is on December 6) fell to around 45% from nearly 65%. Although it may feel like it to Canadian dollar bulls, but the Canadian dollar is not so much out of favor as the greenback is in favor. In fact, over the past three months, the Canadian dollar has fared the second best against the US dollar. Only the Swiss franc has performed better. The Loonie has depreciated by about 3.9%, while the franc has fallen almost 2.9%. Still, Canada's interest rates are below similar US rates, and the Toronto stock market has under-performed. The greenback traded roughly between CAD1.3605 and CAD1.3740 last week and settled around 0.3% on the week slightly above CAD1.3700. A break of CAD1.3600 and ideally the recent lows near CAD1.3570-80, is needed to boost the chances that a high is in place.
United Kingdom: The UK's labor market is softening. The number of payrolled employees fell for three consecutive months through September and wage growth is moderating, especially in the private sector. September inflation was a bit sticky, unchanged at 6.7%, but UK's CPI set to fall sharply this month when last October's 2% jump drops out of the 12-month comparison. Inflation, though, is still pinching consumers and September retail sales fell for the second time in Q3. The UK sees more employment data (claimant count and ILO unemployment measure) and the preliminary PMI, but they are unlikely to persuade the market that the Bank of England will hike rates at the November 2 meeting. With the cumulative effect of past tightening not worked its way fully through the British economy, and near stagnant economic conditions, the bar to another hike seems high. The odds in the swaps market have trended gently lower for the past few weeks and now are near 20%, half of what it was in late September.
Sterling was little changed last week, but the trading range became somewhat clearer. The $1.2220 area marks the nearby top and the $1.2090 held after being tested twice. The sideways-to-slightly lower price action saw the five-day moving average whipsaw around the 20-day moving average but finished the week below it (~$1.2170 vs. $1.2180). Even a move above $1.2220 may not be sufficient to signal an important breakout. For that, a move above $1.2240-50 may be required.
Australia: The new central bank governor Bullock's first speech offered some explanation about the resilience of price pressures. Both the swap and futures market continue price in a bias toward a rate hike, not so much at the November 7 meeting but after that. A quarter point hike is nearly fully discounted by the end of Q1 24. Following last week's disappointing employment report, which revealed a nearly 40k loss of full-time jobs to bring the Q3 drop to around 53k and offsets a rise of a similar magnitude in Q2, Australia reports Q3 CPI. It is expected to slow to 5.2% from 6.0% year-over-year. The underlying measures are also expected to moderate to an average of 5.0% from 5.7% in Q2. The Australian dollar's recovery from successfully testing the year's low set earlier this month near $0.6285 stalled in front of $0.6400. It slipped back through $.6300 where bids continued to lurk. It needs to re-establish a foothold above $0.6400 to remove the downside pressure. A break of the $0.6270 warns to a return to last October's low, another cent lower.
Mexico: Mexico's inflation has been practically halved since peaking last August near 8.8%. The bi-weekly reading that will be updated on October 24 stood at almost 4.50% at the end of September. Progress to return to below 4% is slowing, but the central bank has clearly signaled its intent to keep the target rate at 11.25% for some time. The economy appears to be growing at around a 3.5%-pace and that is what the IGAE report is a reasonable proxy of, and it will be reported the day before the CPI. The first estimate for Q3 GDP is due on October 31. Mexico will report September trade figures on October 27. Mexico runs a trade deficit, but it is small and manageable. The trade deficit this year through is about $8.6 bln. In the first eight months of last year, the deficit was almost $24.75 bln. Through August, Mexico's exports have risen by about 6%. In this context, the $41.5 bln of worker remittances this year through August are remarkable. The dollar approached the seven-month high set against the peso earlier this month (~MXN18.4860) ahead of the weekend, and it held and hte greenback reversed low to MXN18.18 before stablizing. Provided MXN18.50 area holds, it can test to the MXN17.75-80 area. Otherwise, the risk is of a move toward MXN18.80 and possibly the MXN19.00 area. Recall that the high set amid the bank stress in March was near MXN19.23.
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