by Marc Chandler
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An inflection point may have been reached last week. Despite, Chair Powell's insistence that the Fed did not adopt an easing bias and confirmed that there is still no talk of a cut, the market knows better. The implied yield of December 2024 Fed funds futures contract is about 4.45%, which is to say, the market is discounting not only the two cuts in the Fed's September projections, but a third cut, and the risk again (~60%), of a fourth cut. The first cut is now fully discounted by the end of Q2 24. The disappointing employment report pushed on an open door, sending US rates and the greenback lower.
It fits into the evolving narrative of a dramatic slowing of the US economy after the heady 4.9% annualized pace in Q3. This is regarded as a forgone conclusion. It is still early in the data cycle, and the margin of error is large, but the Atlanta Fed's GDP tracker is seeing 1.2% Q4 GDP, and that was before the employment report and the roughly 0.25% decline in aggregate hour worked in October the largest drop in more than two years. That the eurozone and UK are stagnant or worse, or that despite accommodative monetary and fiscal policy, the Japanese economy also likely contracted in Q3. is not marginal new information. The divergence that helped the US dollar recover from the mid-year low may reverse. And that reversal is because of the developments in the US.
The dollar's pullback and drop in interest rates will take pressure off the Bank of Japan and the People's Bank of China. However, the drop in US rates means that quarterly refunding will take place at high prices, which raises questions of demand from price-sensitive market segments. Fed officials will begin explaining themselves, including Chair Powell who is at an IMF-sponsored event on Thursday. China issues several politically sensitive data points, including trade, reserves, and inflation, even though the financial markets' response is usually mild. The Reserve Bank of Australia announces its decision early Tuesday, and given the Australian's dollar's sharp run-up recently, it looks vulnerable if there is not hike. At the end of the week ahead, Fitch will update its assessment of Italy's sovereign debt, which it currently sees as a BBB credit with a stable outlook. Late last month, S&P affirmed its BBB rating for Italy. Moody's is to deliver it verdict on November 17, and it has a negative outlook for its Baa3 (=BBB-) rating.
United States: In a quiet week after the FOMC meeting and US jobs report, there are three highlights. First is the new supply of Treasuries at the quarterly refunding. Many, even if not all observers, link part of run-up in yields to the increase of supply to fund the deficit. Second, with Q3 GDP already reported, as was September's advanced merchandise trade balance, the final September trade figures will be of passing interest. Recall that Q3 GDP unexpectedly showed a small drag from net exports. The US goods deficit widened a little in September (to $85.8 bln vs $84.6 bln in August) but year to date the goods balance has narrowed to about $804 bln from $905 bln in the first nine months of 2022. The overall trade deficit through August this year is about $528 bln after a $666 bln shortfall in the same period last year. Growth differentials and the strong US dollar are expected to be a drag on the external sector. Third, September consumer credit will be reported. It unexpectedly declined in August, tumbling $15.6 bln, the most in more than three years. It was driven by a $27 bln drop in the loans outstanding from the federal government--primarily student loans. Servicing student loan debt resumed this month, but ahead it, borrowers repaid nearly $6.5 bln in September. Despite the elevated delinquency rates, revolving credit (mostly credit cards) rose by $14.7 bln in August, the largest gain this year. The median forecast in Bloomberg's survey sees an $11 bln in overall consumer credit in September. In September 2022, consumer credit rose by $27.6 bln.
The Dollar Index posted a bearish outside down week, trading on both sides of the previous week's range and settling below it low (~105.35). We suspect the rally from the end of July is being "corrected." The next target is around 104.40 initially, the 38.2% retracement of the rally. The (50%) retracement is near 103.45, which is around where the 200-day moving average is found. The Dollar Index gapped lower on November 2. That gap (~105.50-60) looks technically significant and adds to the bearish technical read.
China: There are three economic highlights from China in the coming days, trade, reserves, and prices. A fourth highlight in the form of the monthly lending figures is possible, as well. It is interesting that in dollar terms, Chinese exports and imports have fallen by a little more than 6% year-over-year through September. However, in yuan terms, exports and imports are off less than 1%. In dollar terms, China's trade surplus has averaged $70.05 bln a month through September. It averaged $69.95 in the first nine months of 2022. In yuan terms, the trade surplus averaged CNY489.3 bln in the January-September this year compared with an average of CNY459.3 bln in the same period last year. Given the sell-off in bonds and the general strength of the dollar, it would not be surprising if China's reserves fell for the third consecutive month in October. China's reserves are the subject of much discussion and interest. Some argue that China's reserves are greater than officials report and insist on adding the net currency position of state-owned banks, as if they do not have positions separate from the PBOC. Reserves are what countries declare. China appears to have bucketed some of its foreign assets in other pools, less transparent but not so different than the US. The US Treasury, for example, says "The foreign exchange assets of SOMA (Federal Reserve's System Open Market Account) are not US government assets...", even though it acknowledges that "only the foreign exchange and SDR components of official reserves are assets of the ESF [Exchange Stabilization Fund]" and that foreign exchange holdings are divided between the ESF and the SOMA.
Similarly, all of China's foreign assets are not its reserves, which are self-declared and reported to the IMF. Yet, China appears to be bleeding funds. Portfolio investment is flowing out and retained earnings from foreign direct investment also appear to be leaving China. Further, consider the errors and omissions of its balance of payments data. The quarterly average for the last three years through the middle of this year is about $32.4 bln or almost $400 bln over the period. This likely reflects capital flight. Lastly, the third highlight of the week is Chinese inflation, or the lack thereof. China's CPI disappointed in September, slipping back to 0 from 0.1% year-over-year. It was -0.3% in July. Still, the nascent and fragile recovery that is taking hold will likely have helped CPI, though food prices, and pork play an outsized role. Meanwhile, deflation in producer prices is gradually ebbing. Producer prices have been falling on a year-over-year basis since October 2022. The -2.5% in September was the least deflation in six months. The takeaway is not the precision but the direction.
The US dollar's retreat will aid the PBOC's effort to slow the yuan's descent. Indeed, after the disappointing US jobs data, the greenback tumbled to CNY7.26, its lowest level since mid-September. The fall of a little more than 0.5% was the most the dollar has fallen in a single session since July 25. With such a closely managed currency, it is difficult to speak confidently about technical levels. Still, heavier greenback tone may point to a move toward CNY7.20, and possibly toward CNY7.10, as short yuan positions are covered. Against the offshore yuan, the dollar can test the CNH7.26 area and then CNH7.19. If the offshore yuan trades persistently firmer than the onshore yuan, that also lends credence to the idea that the near-term trend has changed.
Eurozone: Last week's preliminary estimate that the region's Q3 GDP contracted by 0.1% takes some interest from September data. That includes retail sales on November 8. We already know that Germany retail sales disappointed the median forecast in Bloomberg's survey for a 0.5% gain. They fell a revised 1.1% in August (initially -1.2%). France's consumer spending, broader than retail sales rose by 0.2%, which was half of what was expected, following August's 0.6% decline (initially -0.5%). Germany reports September factory orders and industrial output figures. German industrial production fell for four straight months through August. Factory orders appear to have held in better. They have only declined tice in the first eight months of the year, but they were large drops: -10.7% in March and -11.3% in July, which wipes out most of the gains. On average, through August, German factory orders rose 0.1% a month. Last week, the preliminary estimate of October CPI showed a softer than expected 2.9% year-over-year rate. Judging from the base effect, this could be the low print for the next several months. The results of the ECB's survey of inflation expectations will be published on November 8. Recall that in August the one-year outlook was for 3.5% CPI, slightly above the trough of 3.4% in June and July. It was at 5.0% at the end of last year. The three-year expectation stood at 2.5% in August. It reached a low of 2.3% in June and was at 3.0% at the end of last year.
The euro posted a bullish outside up week. It traded on both sides of the previous week's range and settled above its high (~$1.0695). The euro reached almost $1.0750, its best level since mid-September. The US two-year premium over Germany fell by 20 bp over the last three sessions to its lowest level since the end of September (~184 bp). The momentum indicators remain constructive, and the five-day moving average held above the 20-day moving average since crossing it on October 20. A note of caution comes from the close above the upper Bollinger Band (~$1.0680). Like several other currency pairs discussed here, the euro is nearly three standard deviations (~$1.0730) above its 20-day moving average. If the euro is correcting the slide since the late July when the high for the year was set near $1.1275, the $1.0765 area is the (38.2%) retracement objective. Above there, the 200-day moving average slightly above $1.08. The $1.0860 area is the next retracement (50%).
Japan: A common question is why the Bank of Japan did not act more forcefully last week when it downgraded the importance of the 1.0% threshold of the 10-year JGB. Part of the answer may lie with the data released before the outcome of the central bank meeting. Industrial output, which was expected to rise by 2.5% edged up by only 0.2%. Retail sales that were forecast to rise by 0.2% fell by 0.1%. The data reinforced the sense that the Japanese economy contracted in Q3. Recall that it would have contracted in Q2, but inbound tourism was the crucial offset to the contraction in consumer spending and business investment. Also, BOJ officials are not fully convinced that inflation is sustainable. While it did revise up its inflation forecast for the current fiscal year from 2.5% to 2.8% and the FY 24 (from 1.9% to 2.8%), the forecast for FY 25 remains below 2.0% (from 1.6% to 1.7%). Japan reports September labor earnings and household spending early on November 7.
Therein lies part of the problem. Despite what was heralded as a successful spring wage round, August cash earnings were a mere 0.8% higher than a year ago. Adjusted for inflation, it is a loss of 2.8%. That translated into a 2.5% decline in household spending. Japan will also report September's current account surplus, and it is a surplus. In fact, even though Japan reports a chronic trade deficit, it runs a persistent current account surplus (think income earned offshore, such as interest, profits, dividends, royalties, and licensing fees) that has been 2-4% of GDP for the last eight years. Beyond the macro data, many still seem to be unclear about the BOJ's intent. It will be watching for unscheduled bond purchases. Implied volatility of the yen jumped after the BOJ meeting and if it continues to rise, it could provide the cover for intervention in the foreign exchange market. That said, one-week and one-month volatility is well below the levels seen in September-October 2022 intervention operations. Moreover, the BOJ recognizes that the issue is not just about the price of dollars (the exchange rate) but also access. To this end, the BOJ offered to lend dollars against a pool of collateral at 5.58% for a week ending November 9.
In reaction to the BOJ's announcement on October 31, the dollar rallied from about JPY149 to the high for the year slightly above JPY151.70. The greenback has remained in that range and reached nearly JPY149.20 after the US employment report. It finished the week below the 20-day moving average (~JPY149.80). The momentum indicators did not confirm last week's new high, creating a bearish divergence. On the other hand, while the dollar traded on both sides of the previous week's range against the yen, the close was (barely) inside the range, and that neutralizes some of the negative connotations. Still, a close below JPY149.00 could target JPY148.00-50 initially. A break of that area brings the October 3 low, seen amid speculation that the BOJ intervened, around JPY147.45.
Australia: The Reserve Bank of Australia makes its policy announcement early on November 7. The slightly stronger than expected Q3 CPI (5.4% vs. 5.3% median forecast in Bloomberg's survey, after 6% in Q2 spooked the market. New RBA Governor Bullock was cagey about whether it would impact policy. Other recent data, including September employment data (loss of nearly 40k full-time positions) and disappointing October PMI warns that the economy is losing momentum. Still, an IMF staff report encouraged tighter monetary policy and less government investment to cool inflation. The futures market is discounting a little more than a 50% chance of a hike, which is almost double the assigned probability before the CPI report. Prime Minister Albanese visit to China is notable but the market impact is likely minimal at best.
The Australian dollar rallied to its best level in two months ahead of the weekend, amid the broader US dollar pullback and speculation of a possible RBA rate hike next week. The momentum indicators are trending higher. After six previous attempts since mid-August, the Aussie managed to close above $0.6500, not simply trade above it on an intraday basis. Still, it traded nearly three standard-deviations above its 20-day moving average (~$0.6525) and settled higher than two standard-deviations (~$0.6470). After matching its longest advance since January (three weeks) and rising about 2.8% last week (the largest weekly rally since last November), it looks vulnerable if the RBA does not lift rates.
UK: The highlight of the week ahead is the Q3 GDP report. The monthly GDP prints cannot be simply added up to get the quarterly figure. In Q2, for example, the sum of the monthly GDP estimates was 0.7% and the quarterly GDP was 0.2%. The UK economy contracted by 0.6% in July and grew by 0.2% in August. The September GDP and Q3 GDP will be reported at the same time on November 10. After leaving base rate unchanged at 5.25%, as widely expected, the Bank of England cut its forecast for Q3 GDP to flat from the 0.4% projection made three months earlier. It expects a stagnant 2024. In August, it had thought 0.5% growth was likely. Economists surveyed in Bloomberg's monthly survey expect a flat quarter, not only in Q3 but in Q4 and Q1 24. The risk seems to be on the downside. Turning to CPI (November 15), a sharp fall should be anticipated as the 2% surge in October 2022 drops out of the 12-month comparison. UK CPI will still likely be the highest in the G7 but closer to 5% (6.7% in September). Although BOE Governor Bailey says it is too early to begin thinking about a cut in rates, the swaps market thinks otherwise, and a cut begins to be priced in Q2 24 but is not fully discounted until late Q3 24.
Despite the sobering BOE forecasts, and the market bringing forward BOE rate cuts, sterling had a fine showing. Last week's gain of more than 2% was the largest advance since last November. The 1.4% raise ahead of the weekend was the largest since early January, illustrating the impulsive nature of the gains. Sterling reached $1.2390, its best level since September 20. The close above the October high (~$1.2335) may give it another cent, or so, near-term potential, which would see it test the 200-day moving average and meet the (38.2%) retracement objective of sterling's slide since the year's high was recorded in mid-July (~$1.3140). Sterling took out the trendline connecting the two October highs near (~$1.2260). The next technical target may be in the $1.2435-60 area. While the momentum indicators look good, sterling settled above its upper Bollinger Band (~$1.2330) and approached the three standard-deviation mark (~$1.2395).
Canada: There is increasing speculation that Canada is slipping into a recession (two consecutive quarters of economic contraction). The sum of Canada's monthly GDP prints from February through August has been zero. Canada's two-year yield peaked near 5% in the second half of September and early October. It fell below 4.50% last week, a three-month low. As recently as October 9, the swaps market was pricing in another quarter point hike before next July. Now it has a cut of the same magnitude fully discounted. Canada reports the IVEY survey (Monday) and September merchandise trade (Tuesday). The IVEY survey has been holding up better than the manufacturing PMI (which has spent the six months through October below the 50 boom/bust level). Meanwhile, Canada has experienced a deterioration of its trade balance. In the first eight months of 2022, Canada reported an average goods trade surplus of almost C$2.4 bln. This year, through August, Canada has recorded an average monthly merchandise trade deficit of C$750 mln.
The Canadian dollar had its best week in seven months, gaining about 1.50% against the US dollar. It is not a vote of confidence in Canada's outlook, and the jobs data were disappointing (loss of full-time jobs and another rise in the unemployment rate--to 5.7% from 5.5%). Rather, it was more about the US dollar. The CAD1.3660 area frayed ahead of the weekend, which is also halfway point of the rally since the end of September. A convincing break of it signals a test on CAD1.3600 and then CAD1.3500. The momentum indicators are trending lower, and the greenback is not near its lower Bollinger Band (~CAD1.3535). It settled before the weekend below its 20-day moving average (the center of the Bollinger Band) for the first time since late September. Typically, it seems that the Canadian dollar lags on the crosses in a softer US dollar environment.
Mexico: Mexico's economy is proving to be more resilient than expected. The October manufacturing PMI popped back above the 50 boom/bust level (52.1) after dipping below in September. The IMEF surveys slowed but were still in expansion mode. Worker remittances were stronger than expected in September. Consider that in the first nine months of the year, worker remittances have risen by $4 bln from the same period in 2022 to $47 bln. Meanwhile, despite the peso's appreciation last year and this year, the trade deficit has fallen to about $10 bln from more than $25 bln in the first nine months of 2022. Mexican inflation continues to trend lower on several hours before the central bank meets on November 9, October's CPI will be reported. It is likely to have fallen for the ninth consecutive month. The headline and core rates may have fallen around 0.25%-0.40% from 4.45% and 5.76%, respectively. September industrial output is reported the following day, and the recent slowing trend may remain intact. The central bank has made it clear that it is on hold, with the overnight rate at 11.25% for a protracted period, which the swaps market says is at least six more months.
The peso rose by about 3.8% against the dollar last week (to ~MXN17.2830), the largest weekly gain since June 2021. It was fueled by dollar's broad pullback, and we note that among emerging market currencies, the Latam currencies were the top three (Chile, Mexico, Peru). The carry became more significant, arguably, with greater confidence that the Fed is done. Risk-on reflected by strong gains in equity markets also may have contributed. The dollar plunged through MXN17.75, which is a potential neckline of a double top pattern. Its measuring objective is near MXN17.00. The five-day moving average drove through the 20-day moving average for the first time since late September. Ahead of the weekend, the dollar briefly traded three standard-deviations below the 20-day moving average, suggesting that from a technical point of view, it is moved too far too fast. Still, the greenback settled below the lower Bollinger Band (~MXN17.5570) for the third consecutive session. In a consolidative phase, the dollar may be able to recover toward MXN17.60-70. A move above the potential neckline (~MXN17.75) would be disappointing.
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