by Marc Chandler
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The combination of soft US price data and mostly weaker economic data lends credence to a new economic convergence. The economic news stream from Europe, Japan, and China is not particular inspiring. Rather the convergence is driven by the materialism of the long-anticipated slowdown of the world's largest economy. This new convergence is negative for the dollar. Our conservative working hypothesis continues to be that the US dollar's gains from the middle of July are being retraced. While we suspect that more than just a technical correction is unfolding, given the high degree of uncertainty and the uniqueness of the post-Covid business cycle, prudence dictates taking it one step at a time.
The near-term risk is that the market has gotten ahead of itself. The US data are likely to confirm a sharp slowdown at the start of Q4, but the market is pricing in nearly four rates cuts by the Federal Reserve, with around a 75% chance the first one is in next May. It is difficult to anticipate the pendulum of expectations swinging more in that direction without more encouragement. Fed officials (and central bankers) may lean against what might be seen as premature easing of financial conditions. Outside of the preliminary PMI, the highlights in what will be a holiday-shortened week for the US, are the UK's Autumn Budget and Canada's CPI. Japan reports its October CPI, but Tokyo's data a few weeks ago steals its thunder. The oil prices have declined for four consecutive weeks, taking crude down around 12.5%. The correlation between changes in oil prices and interest rates/breakevens, is not particularly robust. Still, if the drop in oil is sustained, and it appears to be helping depress average retail gasoline prices (in the US), there could be more significant knock-on effects.
United States: After almost 5% annualized growth in Q3, the world's largest economy is going to slow in Q4, and the key issue question is the magnitude. The median forecast in Bloomberg's monthly survey is for a 0.7% expansion on an annualized basis. Fed Chair Powell was spot-on with his observation that the Summary of Economic projections are simply snapshot of official thinking and that as the quarter progresses, the views become dated with new information. Recall that in December 2022, the median forecast by Fed officials was that the economy was going to grow by 0.4% this year. It has been steadily lifted and in September stood at 2.1%. Yet, the US economy has grown by that much through the first three quarters. Following a slowing of job growth in October and weaker retail sales and industrial production, the data in the holiday-shortened week ahead should show more softness.
Existing home sales are expected to have fallen for the fifth consecutive month in October. Durable goods orders are seen falling (~3.4%). It would be the third decline in four months. Note that Boeing's orders slowed to a still strong 119 in October from 224 in September. Its backlog of orders reached 4,578 planes, worth about $440 bln, and that was before the latest announcement of new orders from Middle Eastern airlines (~94 planes). The October Leading Economic Indicator Index has been falling without fail beginning April 2022. The six-month annualized decline has been moderating since March (-9.0%) to -6.7% in September and this trend may have continued, albeit slightly in October. The University of Michigan updates is November survey that showed a rise to 4.4% of the one-year inflation expectations, up from 4.2% in October and 3.2% in September. Fed officials seem to put more stock in the 5–10-year expectations. They rose to 3.2% in the initial estimate up from 3.0% and a new high since 2008. The NY Fed's survey showed one-year consumer inflation expectations slipped to 3.57% in October from 3.67% in September. It is a three-month low. The three-year expectation was unchanged at 3.0%. The three-year breakeven (difference between inflation-linked security yield and the conventional yield) is about 2.2% and the one-year breakeven is around 2.12% (vs. 2.23% at the end of October). The one-year breakeven is near 2.07% (vs.2.25% at the end of October).
The US also sees the preliminary PMI at the end of the week. The readings are holding slightly above the 50 boom/bust level. The composite was at 50.7 in October, a three-month high. It has been below 50 since January. Lastly, recall that the market initially saw the FOMC statement earlier this month as hawkish but then interpreted the Fed Chair as dovish. This seemed to be a stretch to us at the time, and, in any event, the market corrected itself after Powell's comments at an IMF discussion, as if that is where a change would be announced. Still, the Fed's stance seems straigth-forward: Policy is restrictive, but it is not clear whether it is restrictive enough. The Fed is prepared to raise rates again, if necessary. The market judges it will not be necessary. The futures market has a little more than almost a 75% chance that the first rate cut will be delivered in May 2024, and it has 92 bp in cuts priced in for all next year. That is three quarter-point cuts and a 70% chance of a fourth rate reduction.
The Dollar Index fell by more than 1.7% last week, its largest decline in four months. It repeatedly tested the 104.00 level since November 14 CPI report and finally broke through it ahead of the weekend. The low was slightly above 103.80. The next area of technical support is seen around 103.45-103.60. We suspect it may head toward 102.55, the (61.8%) retracement of the rally since the mid-July low (~99.60) to the early October high (~107.35). Resistance may be encountered in the 104.50 area.
China: Without a cut in the one-year Medium-Term Lending Facility (MLF) rate last week, Chinese banks seem to be under little pressure to reduce their prime rates. In fact, recall that following August's 15 bp reduction in the MLF rate (to 2.50%), the one-year loan prime rate was cut by 10 bp (to 3.45%), while the five-year loan prime rate has been steady at 4.20%. Still, the PBOC offered CNY1.45 trillion (~$200 bln) through the MLF, which is more than double the amount of funds coming due this month. Some argue that this injection is roughly the equivalent of a 25 bp cut in reserve requirements. Next week, the PBOC will issue CNY45 bln (~$6.2 bln) in T-bills in HK. This may absorb some of the excess liquidity and support the yuan. Reports suggest that ahead of Biden-Xi meeting, China's buyers, including Sinograin, bought 3 mln metric tons of soybean in almost a dozen agreements struck. US beans are more expensive than Brazil's, but these beans may be headed for storage. With less moisture and lower oil content, US beans may store better. Other reports suggest China is considering buying Boeing's 737 Max airplane. On the other hand, the day before the heads of state meeting, the main US federal government pension fund announced that it would adopt a new benchmark which excludes Hong Kong, in addition to China, which had previously been dropped.
The yuan's 1% gain last week was the most in in four months. The dollar peaked in September near CNY7.35 and approached CNY7.2050 ahead of the weekend, its lowest level since mid-August. A break below CNY7.19 could signal a move toward CNY7.10-12. The rolling 30-day correlation between changes in the yen and offshore yuan reached a new high for the year near 0.69 ahead of the weekend. The 60-day correlation is near 0.57 and the high for the year was set in April closer to 0.60. The correlation between changes in the euro and offshore yuan are firm though lower than the yen.
Japan: Japan's CPI will draw media attention and headline traders, but the new information is very limited. The Tokyo CPI that was reported on October 27 is the signal. What it is telling us is that the national measure most likely rose again. The headline rate may rise from 3.0% toward 3.4%. The core measure, which excludes fresh food, may have risen to 3.0% from 2.8%. The measure that excludes fresh food and energy was unchanged in Tokyo (3.8%), while the national measure was at 4.2% in September. Bank of Japan Governor Ueda is putting more weight on wages. This year's spring wage round produced an average base pay gain of 3.99%, the most in 30 years. Yet, real household spending s 2.8% lower year-over-year in September. It has not been positive since October 2022. The weakness of the yen and the end of the pandemic has seen tourist flock to Japan. Tourism last month surpassed tourism in October 2019. Tourists from South Korea were up three-fold from October 2019, while visitors from Taiwan, Singapore and the US surpassed the trips pre-pandemic too. Chinese tourists were the largest before the pandemic and were off by around 65% last month from pre-pandemic levels.
The dollar returned to this month's low near JPY149.20 ahead of the weekend. Falling US rates and a short squeeze in the JGB market seemed to be the key drivers. The 10-year (generic) JGB yield was slightly above 0.97% at the start of the month, and, at the end of last week, spiked to about 0.72%, the lowest since late September. The five-day moving average (~JPY150.75) has not traded below the 20-day moving average (~JPY150.50) since the end of July. A crossover now could be a proxy for moving average crossover systems behind some model-driven segments. Below JPY149.20 is the low from late October (~JPY148.80) for intermittent support ahead of JPY148.00.
Eurozone: We suspect the eurozone economy is bottoming out. It does not mean that there are strong growth impulses, but the drip feed of poor economic news may be ending. The main report in the week ahead will be the flash PMI. The readings are so weak that it will likely take a several months for the composite (46.5 in October) to recover above the 50 boom/bust level. The market has almost a 90% chance that the ECB delivers its first cut in April 2024, and nearly a 90% chance that three cuts are delivered by the end of Q3 24. The market did not punish Spain for the political uncertainty following the July elections and the reaction was muted when Sanchez secured his third term as prime minister. The price will be greater dependence on the Catalan separatist. Portugal is in a somewhat different position. A corruption probe has toppled the Costa government and an election will be held in March 2024. The 10-year yields in Portugal and Spain fell by 17-18 bp last week, seeing their premium over Germany narrow by around five basis points. Lastly, we note that Moody's upgraded the outlook for Italy's credit to stable and affirmed its lowest of investment grade status. The 10-year Italian bond yield fell 20 bp last week.
The eurog pushed to $1.0915 at the end of last week, its best level since the end of August. The next upside target is the high from late August around $1.0945 and the (61.8%) retracement of the decline from the mid-July high (~$1.1275) that is found near $1.0960. Momentum indicators are rising but getting stretched. Initial support has formed around $1.0825. Better support may be found closer to $1.08, which holds the 200-day moving average and the (38.2%) retracement of the rally from the November 10 low (~$1.0655).
United Kingdom: The UK Chancellor of the Exchequer Hunt presents the Autumn Statement on fiscal policy on November 22. There appears to be pressure from the Tories to allow fully expensing (deducting from taxable profits) investment in machinery and buildings, which Hunt estimates will cost the government GBP10 bln. Hunt has also promised to address labor supply and build on the 30 hours of free childcare announced in the Spring Budget. The Tories continue to trail behind Labour by a wide margin. The UK must hold an election by the end of January 2025, and many expect it to be called late next year. The UK also sees its preliminary November PMI. The composite fell back below 50 in August and has not been able to resurface the threshold. The UK economy stagnated in Q3 and the median forecast in Bloomberg's monthly survey look for stagnation to continue this quarter and next. After stronger jobs growth and softer inflation, the UK reported a disappointing 0.3% decline in October retail sales ahead of the weekend. The swaps market is pricing about a 55% chance of a cut next May and it has two rate cuts fully discounted by the end of Q3 24.
Sterling had a good week, rising by about 1.5% against the dollar, but it was front-loaded. The high for the week was set on Tuesday after the US CPI a little above $1.25, its best level in two months. It consolidated lower in the second half of the week mostly between $1.2375-$1.2460. The momentum indicators suggest there may more near-term upside potential. Last week, sterling met the (38.2%) retracement objective of the sell-off since the mid-July high (~$1.3140) found near $1.2460. The next retracement (50%) is near $1.2590. A break of $1.2350 would be disappointing, while falling below $1.2300 would suggest the upside correction might be over.
Canada: There are three highlights in the week ahead. First is the October CPI on November 21. The base effect suggests the headline rate may ease back toward 3.3%. Recall that it bottomed in June at 2.8% and rebounded to 4.0% in August before slipping to 3.8% in September. Canada's CPI rose at an annualized rate of about 3.6% in Q3 after 4.8% in Q2 and 5.2% in Q1. The Bank of Canada puts an emphasis on the underlying trimmed and median core rates and has expressed concern about the lack of progress in recent months. The trimmed mean has been chopping between 3.6% and 3.9% since May, while the median core rate has been 3.8%-4.1%. Second, a few hours later, the Canadian government will provide its fall economic update. It might not be market-sensitive in itself but the Bank of Canada recently suggested that the fiscal policies of the federal government and provinces may be contributing to the inflation challenge. Third, at the end of the week, Canada reports September retail sales. Consumption slowed sharply in Q3, rising by only 0.2% (seasonally adjusted annual rate) after Canadian consumer splurged in Q2 (4.7%). August's 0.1% decline in retail sales probably overstated the case and small gain is likely.
The Canadian dollar was the weakest of the G10 currencies last week, with around a 0.6% gain. The yen, which was the second weakest, rose 1.25%. The Canadian dollar often lags in a soft US dollar environment. Still, we suspect the greenback is carving out a topping pattern against the Canadian dollar. If this is to remain a valid working hypothesis, the US dollar needs to hold below the CAD1.38 area. The momentum indicators are trending lower and the five-day moving average (~CAD1.3730) is below the 20-day moving average (CAD1.3770). On the downside, it would ideally close below CAD1.3675 at the end of the week ahead.
Australia: The minutes from this month's central bank meeting, which decided to lift the target rate for the first time since June will be published on November 21. It was the first hike under the leadership of Governor Bullock. The swaps and futures market still have the risk of another hike discounted. The preliminary November PMI will reveal whether October's decline in the composite to a new low for the year (47.6) noise or the signal. There are two other developments to note. First, it looks increasingly unlikely that Australia will conclude free-trade agreements with either the UK or the eurozone until at least well into next year. Second, the center-left government announced it would scrap more than 50 rail and road infrastructure projects due to cost overruns and fears, underscored by the IMF, that significant infrastructure spending threatened to worsen price pressures. The government may project new funding for infrastructure in its mid-year economic review expected in the coming weeks, while pursuing a 50/50 split with state governments.
The Australian dollar had a good week, gaining slightly more than 2.4% on the greenback to reach its best level in three months. It was the third consecutive week that the Aussie has had a net change of 2% or more. It has not done this since August-September 2021. The Australian dollar peaked in the middle of last week near $0.6540 and spent the last two sessions consolidating. It found support ahead of $0.6450. Around $0.6510, the Aussie met the (38.2%) retracement of the decline from the mid-July high (~$0.6900). The next retracement (50%) is about $0.6585, and the 200-day day moving average is a little higher (~$0.6595). The momentum indicators are rising but getting stretched.
Mexico: The initial estimate that Q3 GDP rose by 0.9% quarter-over-quarter is subject to revision, but it makes the September retail sales report on November 22 somewhat less important for the market. The CPI for the first half of November is more interesting. We note that the pace of improvement appears to be slowing. A few hours after the CPI report, minutes from November 9 central bank meeting will provide some more insight into how officials are thinking about the economy. Recall that the statement after the meeting modified the language around how long the overnight target will be kept at 11.25% from "a long time" to "some time". The central bank also trimmed its inflation forecast to an average of 4.4% in Q4 23 (from 4.7%) and 4.3% in Q1 24 (from 4.4%). Separately, Argentina's run-off presidential election is on November 19. Regardless of the results, Argentina's economy is in a difficult place, with triple-digit inflation, over-indebted, and low international reserves. A large devaluation seems nearly unavoidable.
The greenback reached almost MXN17.94 on November 10, reversed lower and recorded a low near MXN17.19 at the end of last week. After settling lower for five consecutive sessions, the dollar eked out a small gain before the weekend. The momentum indicators are still falling, and chart support is not seen until MXN17.00-10. Initial resistance may be around MXN17. 35.
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