by Marc Chandler
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The markets absorbed two shocks last week. The war in Israel that seems to know of no restraint underpinned oil prices and appeared to help boost gold and the Swiss franc, the only G10 currency to appreciate against the dollar. The other was the continued deluge of US Treasury supply, the coupon auctions that tailed and higher than expected PPI and CPI. Nevertheless, the US 10- and 30-year yields fell nearly 20 bp last week, snapping a six-week uninterrupted increase. In fact, it was only the second weekly decline since the week ending July 21--a dozen weeks ago.
We suggested early last week that provided the war in Israel remains contained, the markets can focus on macroeconomic drivers. This still seems like a fair assessment and December WTI, which gapped higher on Monday drifted lower in the next few sessions to close the gap before jumping ahead of the uncertainty of the weekend and amid Iran's threat to open a new front in the war if the blockade and assault on the Gaza continued.
The focus on the US economy shifts from prices to the real sector in the days ahead. In particular, the date should show a loss of economic momentum as Q3 wound down, setting the stage for a more dramatic slowdown in Q4 from what the Atlanta Fed's GDP tracker puts slightly above 5%. Beijing has an opportunity to provide more monetary support, but the disappointment with the CPI (flat from 0.1% year-over-year) seems to be the result of food prices that may have been lowered ahead of the October holiday but the economic focus will be on the Q3 GDP, seen to accelerate over Q2 and details for September. The UK and Canada report September CPI. The UK will also report on the jobs market. Expectations for the respective central banks will be sensitive to these high-frequency data points. The swaps market puts the odds a little under 50% for the BOE and a little above 50% for the Bank of Canada.
United States: Throughout the post-Covid economic recovery, many economists have been skeptical, and recession calls have only recently been rescinded. To be sure, it is not just private sector economists. Remember last December, the median forecast by Fed officials was for the economy to grow by 0.4% this year. That was raised to 1% in June and to 2.1% in September. The Atlanta Fed has the economy tracking 4.5% in Q3. The median forecast in Bloomberg's survey is 3.0%, however, it falls to 0.5% in the current quarter. For this to be fair, the economy would have lost momentum into the end of Q3. While the headline nonfarm payrolls figures leaped by 336k, we remain struck by the details, including the loss of full-time positions for the third consecutive month (seasonally adjusted), a surge in uncontracted self-employed (gig workers), and a rise in people who hold two full-time jobs. We look for the data in the coming days to confirm a loss of momentum.
Core September retail sales (excluding autos, gasoline, building materials, and food services) may have declined for the first time in six months. A 0.3% decline would put the annualized rate in Q3 around 2% after almost 6.5% pace in Q2. After rising by more than 1% in July and August combined, industrial output is expected to fall slightly, led by a 0.2% decline in manufacturing. Existing home sales are seen falling for the fourth consecutive month, and the 3.5% decline projected by the median forecast in Bloomberg's survey would be the largest of the year. The index of Leading Economic Indicators has not risen since February 2022 and most likely did not change directions last month. The six-month annualized decline has stabilized in recent months but at -7.5% in August (-9.0% in March), it is still at levels seen in past recessions. Housing starts may be an exception to this trend of weaker data. They tumbled 11.3% in August and are expected to have bounced back by nearly 10% in September. Two regional Fed surveys for October are due. The NY State manufacturing survey recovered smartly in September (1.9 from -19.0 in August) but is likely to have fallen back below zero in October. October Philadelphia Fed's business outlook is due on October 19. The diffusion index has been negative since September 2022 with the sole exception in August before falling back in September. Lastly, the Fed's Beige Book, in preparation for the October 31-November 1 FOMC meeting will be released.
The Dollar Index recorded an outside up day in what seemed like an overreaction to the US CPI, which missed the median forecast by 0.1%. In doing so, it met the (61.8%) retracement objective of its pullback that began from the peak on October 3 near 107.35. That retracement target of 106.65 was exceeded ahead of the weekend as the Dollar Index knocked on 106.80. Recall that the 107.20 area is the halfway mark of the decline from last September's multiyear high (~114.80) to the mid-July low around 99.60. While there may be resistance around 108.00, the next retracement target is closer to 109.00. On the other hand, a break of the 105.25 area strengthens the case that a top is being forged. We note that the five- and 20-day moving averages did not cross as looked likely. The five-day moving average (~106.20) has remained above the 20-day moving average (~106.10) since late July. It offers one way to think about the trend.
China: There are three things to watch in the coming days in China. First are interest rates. Beijing will set the benchmark one-year Medium Term Lending Facility (MLF) rate before early Monday. After the flat CPI (year-over-year) in September, there is a risk that it will be cut, but more likely it will be left unchanged at 2.50%. The volume may be reduced a little from the CNY591 bln last month. However, it does mean that most likely, banks will maintain the prime rates, even though the last cut in the MLF was not fully passed through. Second, early on October 18, Beijing will announce how the economy performed in Q3. After growing by 0.8% in Q2, China is expected to have grown by 1% in Q3. This would bring the cumulative growth this year to around 4%. The target is 5%. It will also report some of September's details, including industrial production, retail sales, and fixed asset investment. In addition, the latest readings on the property market will be reported. Third, press reports suggest Beijing is considering boosting government borrowing by as much as CNY1 trillion (~$137 bln), and overshooting the 3% budget deficit cap, to provide more support for the economy. Ostensibly, the funds would be used to fund more infrastructure projects, and water projects were specifically cited.
China's mainland markets re-opened from the extended holiday. Despite the sovereign wealth fund buying Chinese bank stocks and talk of another fund to support equities failed to prevent Chinese stocks from falling last week, even though all the other large markets in the region rose, with Japan, Taiwan, South Korea, Australia, and Hong Kong indices raising more than 1%. In fairness, the index that tracks mainland companies that trade in HK rose nearly 2.4%. The yuan softened slightly and as it has done since late August, alternating between weekly gains and losses. Using formal and informal levels, Chinese officials have stabilized the yuan, but with policy divergence still a key driver, and foreign portfolio investors still apparently reluctant to jump back in, the risk is for a weaker yuan. It should not be surprising if Chinese officials step up their efforts if the dollar nears CNY7.3125-75. Still, we suspect that if the dollar moves above JPY150, and strengthens more broadly, Beijing will begrudgingly accept further gradual yuan weakness.
Japan: Industrial production in Japan fell 1.8% in July and the preliminary estimate was for a flat showing in August. That is subject to revision. Japan's industrial output is volatile on a month-to-month basis. The average monthly change last was zero. If the August reading holds, then the average change this year is -0.1%. The tertiary industry index is reported the following day. It rose at an annualized pace of 2% in Q1 and 4% in Q2. Japan's September trade figures are due also. With one exception (2014), the September trade balance always (past 20 years) improved from August. In August, Japan reported a trade deficit of JPY937.8 bln (~$6.5 bln). Through August, Japan has run a trade deficit of almost JPY8 trillion, down from JPY12.2 trillion in the first eight months of last year. Despite the cheap yen on a trade-weighted basis, Japanese goods exports fell on a year-over-year basis in July and August, the first declines since late 2020.
The national CPI will be released ahead of the next weekend. It is not that it does not matter, but the thunder has been stolen by the Tokyo figures, reported a few weeks ago. Here is what we know: Tokyo's headline pace slowed to 2.8% from 2.9%. The median forecast in Bloomberg's survey was for 2.7%. The core rate (excluding fresh food) slowed a little more than expected, to 2.5% from 2.8%. The measure that excludes fresh food and energy slowed to 3.8% from 4.0%. The nationwide headline measure has been stuck at 3.2%-3.3% since May. It peaked in January at 4.3%. The core rate was at 3.1% in August (and July). Excluding fresh food and energy, nationwide inflation was at 4.3%, the cyclical high seen in three of the past four months. It has not been below 4% since March. Last September, it had risen 1,8% over the previous 12 months.
In response to the US CPI, the dollar reached its best level against the yen (~JPY149.85) since the October 3 drama when the JPY150 level was momentarily breached. The market is cautious even though most seem to agree with our assessment that there likely was no material BOJ intervention. The cover needed may be a further rise in US yields. Despite the firmer PPI and CPI, the heavy Treasury supply, tailed coupon auctions, and the rise in oil prices, the 10-year US yield settled about 16 bp lower on the week. Recall that the yield had risen by about 40 bp since last month's FOMC meeting and its strong endorsement of the soft-landing higher-for-longer narrative. We suspect a close below the 20-day moving average (~JPY148.85), especially if it corresponds to softer US yields, perhaps on the back of weaker economic data, could signal a more important correction. The dollar has not closed below its 20-day moving average against the yen since late July. Below there, the October 3 low near JPY147.45 would be the next target.
Eurozone: The high-frequency data includes the German ZEW survey, eurozone, August construction output, and the external account. There are some strong seasonal patterns with the eurozone trade balance. Without fail for the past 20 years, the trade account deteriorates in August and without fail improves in September. The July surplus was 6.47 bln euros. In July 2022, the trade deficit was 36.3 bln euros. We already know that Germany's goods balance narrowed for the second consecutive month to stand at 14.4 bln euros in August, down from 18.1 bln in July and 22.2 bln in June. France also has reported its August trade balance. Its deficit widened slightly to 8.2 bln euros from 8.1 bln. Last August, France reported a 14.76 bln euro deficit. The broader measure, the current account, has begun normalizing or reaching a new normal. In the year before Covid, the eurozone recorded an average monthly current account surplus of 24.9 bln euros a month. In 2021, the average monthly current account surplus was 28.8 bln euros. The terms of trade shock sparked by Russia's invasion of Ukraine pushed the eurozone into a deficit and it averaged a 9.3 bln euro shortfall a month in 2022. Through July, the eurozone has recorded an average current account surplus this year of 14.9 bln euros.
The euro retraced (61.8%) of its recent advance following the US CPI and posted a bearish outside down day. Follow-through selling ahead of the weekend saw the euro fray the $1.05 area. A convincing break would signal a return to the $1.0450 low made earlier this month and possibly $1.04, which is the (50%) retracement of the euro's rally from last September's multi-year low near $0.9525 to the mid-July high close to $1.1275. If $1.05 more or less holds, the euro must reclaim the $1.5060 area to signal another run toward $1.0645-50 as the correction continues.
United Kingdom: The swaps market is pricing in about a 1-in-4 chance of a Bank of England hike when it meets next on November 2, the day after the FOMC meeting concludes. The data in the coming days are going to shape the expectations. The employment data (October 17) are important, especially the wage component. That said, employment on a three-month over three-month metric fell by 207k in July, the biggest drop since October 2020. The September CPI, the following day, is also important. A 0.3% month-over-month rise would allow the year-over-year rate to slip to 6.5% from 6.7%. It would be the slowest pace since February 2022. A 0.3% increase would mean that the UK's CPI in Q3 rose at an annualized rate of less than 1%. In Q2, it rose at an annualized rate of 8%. Unlike most G10 countries, the UK's core rate has slowed to below the headline pace. The core stood at 6.2% in August. The January print of 5.8% is the low for the year. The September retail sales report on October 20 may not impact the interest rate outlook but will shed light on the strength of the consumer. Retail sales fell by 1.5% last September, meaning a flat report this September would erase the 1.4% year-over-year decline.
Sterling surpassed the (61.8%) retracement target of its rally from the October 4 low near $1.2035 to the October 11 peak three cents higher. That retracement is near $1.2150, and sterling approached $1.2130 before the weekend. Nearby resistance is seen in the $1.2200-25 area, but price action warns of a return to the early October low. Intermittent support may be seen near $1.2100.
Canada: Canada's economic calendar is chock full in the coming days with a report nearly every day. On Monday, the market may not be so interested in wholesale sales and manufacturing sales but may be more interested in the Bank of Canada's business survey results. The economy unexpectedly contracted in Q2. Housing starts, and international transactions on Tuesday are not typically market movers, and in any case, will be overshadowed by the September CPI. The risk here is on the upside. Last September, Canada's CPI rose by 0.1%. If it rose by this year's average of 0.5%, the year-over-year rate will rise for the third consecutive month. It would reach about 4.4%, which would match the highest since February.
The Bank of Canada puts more weight on the underlying core measures. The problem is that the trimmed mean and weighted median measures are sticky, and the central bank has noted it. The trimmed mean rose by 0.3% in August to 3.9%. It was the first increase since last October, but it offset the recent decline, and is at the highest level since April. The weighted median has not fallen since May. It stood at 4.1% in August, which is also the highest since April. Another firm reading and the market may have to take more seriously the risk of a rate hike. The swaps market is currently discounting a little more than a 25% chance of a hike at the October 25 meeting and about a 45% chance of a hike before the end of the year. The calendar is light on Wednesday, and Thursday's industrial and raw material prices do not draw much attention. Instead, Friday (October 20), August retail sales pose headline risk. In July, headline retail sales rose by 0.3%, but were held back by weak autos. Without autos, retail sales rose 1.0%, which offset in full the decline posted in May and June. We know that auto sales rose by about 1.5% (seasonally adjusted) in Land rose another 3.7% in September.
The US dollar extended the pullback from the CAD1.3785 high on October 5 to a low near CAD1.3570 in the first part of last week. It jumped to CAD1.3700 after the US CPI to meet the (61.8%) retracement objective. It stalled ahead of the weekend and sipped back to almost CAD1.3635 area. The next area of support is seen in around CAD1.3600-20. A break of CAD1.3560 is needed to signal a deeper greenback correction.
Australia: The Australian dollar may see new lows for the year before the employment data is reported early on October 19. Through August, Australia has grown an average of 37.7k jobs a month, of which 23.3k have been full-time posts. In the first eight months of 2022, the averages were 50.1k and 51.1k, respectively (a small net loss of part-time jobs). The market sees little chance (~6%) of a rate hike at the November 7 meeting and less than a 25% chance of a hike before the year's out. It had been twice that before the Reserve Bank of Australia met earlier this month. It leaves the Aussie vulnerable to a backing up of US rates, when Australia's two-year discount to the is more than 110 bp. The US premium has not been much more than 120 bp since March. In what will be a blow to the center-left government, Australian voters appear set to reject a proposal that would establish indigenous advisory committee to parliament. The immediate political consequences for the Albanese-led government are modest and the economic consequences, less so. The Australian dollar unwound the six-day rally ahead of the weekend falling back to $0.6285, the year's low set earlier this month. There is little in the way of last October's two-decade low around $0.6170.
Separately, New Zealand looks poised to put in a new government, led by the National Party and its conservative ally ACT. It will likely require the support of the New Zealand First Party to secure a majority. NZ First and Labour have ruled out working with each other in campaign declarations. Still, it might not prevent the New Zealand dollar from succumbing to the pressure of a rebounding greenback and retesting the $0.5860 area.
Mexico: The peso benefited from local developments and the broader decline in the greenback. However, the peso stalled as the dollar recovered and US rates rose after the September CPI report. Mexico reported a continued easing of price pressures (September CPI 4.45% and 5.76% core) and a firm August industrial production (0.3% month-over-month and a 0.3% rise in manufacturing output). Industrial production has risen at a 6.3% annualized rate in the three months through August., the same manufacturing. The data highlight in the week ahead is not until the end of the week: August retail sales. A modest rise will not prevent the year-over-year rate from falling for the second consecutive month. In August 2022, retail sales rose by a heady 1.1%. Mexico's retail sales have risen by an average of 0.4% a month through July, while last year's average monthly increase was 0.6%. Such an outcome in August would see the year-over-year rate fall to 4.4%-4.6%. More broadly, the IMF revised up its June forecast for Mexico's GDP by 0.6 percentage points this year and next to 3.2% and 2.1%, respectively.
The dollar's movement against the Mexican peso has followed the general pattern discussed above. Its gains accelerated in the first part of October, reaching almost MXN18.49 on October 6, its highest level since March. It pulled back to about MXN17.7550 before the US CPI report and then bounced back to around MXN18.0850 before consolidating ahead of the weekend below MXN18.00. That pullback met the (61.8%) retracement of the dollar's gains since the low in late September. A break of last week's low could signal a return to the September low near MXN17.35. On the upside, a break of the MXN18.12 may be a signal that the position squaring may not be over.
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