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The Pendulum of Fed Expectations Swings Too Hard

The Pendulum of Fed Expectations Swings Too Hard

Overview: The capital markets' reaction to softer than expected CPI was too much. The implied yield of the December 2024 Fed funds futures fell by 25 bp as if the October's CPI was worth a full quarter-point rate cut next year. US two- and 1-year yields are around two basis points higher today and the dollar is mixed, with the euro and sterling under the most pressure. China's data were uninspiring, and more stimulus is in the pipeline. Japan's Q3 GDP contraction was sharper than expected, while the UK's CPI slowed more than projected. Biden and Xi are to meet today with Biden speaking to the press late in the North American afternoon. US retail sales are expected to support ideas that the Q3 shopping spree is not sustainable. 

Global equities have rallied on the US coattails. Most of the large markets in the Asia Pacific region rose more than 1%. Europe's Stoxx 600 is up about 0.6%, its third consecutive advance. US index futures are also enjoying a firmer tone. Asia Pacific bond yield tumbled, in a catch-up move. European benchmark yields are mostly softer, with UK Gilts being the outlier, rising a couple of basis points. Soft yields and the dollar's setback are helping gold recover. It frayed the 200-day moving average on Monday (~$1935) and is pushing above $1970 today. Resistance is seen closer to $1979. December WTI is pulling back after approaching $80 a barrel yesterday.

Asia Pacific

The PBOC left its one-year Medium Term Lending Facility rate unchanged at 2.50% and pumped up the lending volume to CNY1.45 trillion, nearly double last month's amount. Separately, the monthly real sector data reports showed steady industrial output (4.6% year-over-year vs 4.5%) and an increase in retail sales (7.6% year-over-year vs. 5.5% in September). However, year-to-date, year-over-year retail sales ticked up flattish at 6.9% from 6.8%). Fix asset investment slowed to 2.9% from 3.1% (year-to-date, year-over-year). Property investment was off 9.3%, after falling 9.1% in September, while sales fell 3.7% (3.2% in September year-to-date, year-over-year). The survey jobless rate was also steady at 5.0%. China has announced a series of new fiscal measures and added support for the property market is being considered. The IMF's new forecast is for the Chinese economy to grow 4.2% next year, which seems on the low side. The takeaway is that the comparisons with last year when activity was depressed by Covid may exaggerate the strength. Month-over-month industrial output rise by almost 0.4% after almost the same in September, broadly similar to a year ago. Retail sales edged up by less than 0.1% month-over-month. 

The Japanese economy contracted by more than expected. The median forecast in Bloomberg's survey looked for a 0.1% quarter-over-quarter contraction, and instead output fell by 0.5%, for a 2.1% annualized rate. The Q2 expansion was revised to 1.1% quarter-over-quarter (from 1.2%) or a 4.5% annualized rate. Net exports swung from a 1.8% boost to GDP in Q2 to a 0.1% drag in Q3. Business spending unexpectedly continued to contract. The 0.6% quarter-over-quarter decline compares with the median forecast of a 0.1% gain. Private consumption disappointed too. First, the drag in Q2 was revised to -0.9% from -0.6% and it was flat in Q3. Economists had expected a small recovery. Japanese officials like their Chinese counterparts are not satisfied with the economic performance and last week the cabinet approved a new economic package worth over JPY17 trillion (~$112.6 bln) that included income tax cuts and support of low-income households and extended subsidies for energy. 

Australia's wage index rose 1.3% in Q3 after increasing by 0.9% (initially 0.8%) in Q2. That is the largest quarterly rise since at least the late 1990s and lifts the four-quarter average to almost 0.96, which matches the highest since early 2009. Australia updates it employment situation tomorrow with the October jobs report. In the first nine months of the year, Australia grew an average of 33.6 jobs a month, or which almost half (15.5k) were full-time posts. In the Jan-Sept 2022 period, Australia added an average of 47k jobs a month and 49k full-time jobs (net loss of part-time positions).

The dollar's sell-off snapped a six-day rally against the yen and reinforces the sense that greenback is toppish near JPY152. A break of JPY150 targets last week low near JPY149.20, though the trendline from the early October low, and the late October and early November lows is found today around JPY149.60. Still, the JPY149.20 could be the potential neckline of double top, which, if triggered, could signal potential toward JPY146.60. The Australian dollar surged above $0.6500, which had proven to be a formidable for the past three months. A false break took place earlier this month when the Aussie peaked slightly below $0.6525. The $0.6510 area is the (38.2%) retracement objective of the Aussie's sell-off since peaking near $0.6900 in June and retesting it in July. The next retracement (50%) is around $0.6585, while the 200-day moving average is about $0.6600. The dollar fell to nearly CNY7.2335 today, its lowest level in around three months. It has steadied in the CNY7.24-CNY7.25 range. The PBOC fixed the dollar lower at CNY7.1752 (it has been in the CNY7.1765-75 area). Compared with the average projection in the Bloomberg survey (CNY7.2452) the gap is the narrowest in several weeks. 


Headline inflation in the UK tumbled to 4.6% in October from 6.7% in September. The key, as we have noted, was that the 2% increase in October 2022 drops out of the 12-month comparison and was replaced by an unchanged figure from last month. The other measures were stickier. The core measures slowed to 5.7% from 6.1%, which brings it to match its lowest level since early last year. Service prices pressures moderated to 6.6% from 6.9%. At the end of last year, the UK's service price inflation stood at 6.8%, twice the pace seen at the end of 2021. Separately, the UK reported deepening deflation among input and output prices. Output prices fell -0.6% year-over-year from a revised 0.2% gain in September, initially -0.1%. Input prices were 2.6% lower than a year ago -2.1% (initially -2.6%). Ahead of the weekend, the UK is expected to report a 0.5% increase in retail sales, which it true, would be the largest increase in seven months. Lastly, note that the UK Supreme Court ruled against the government plans to export asylum seekers to Rwanda.

Yesterday, Eurostat confirmed that the eurozone economy contracted by 0.1% in Q3. It makes today's news of a 1.1% contraction in the region's industrial output in September redundant. It followed a 0.6% increase in August after a 1.3% decline in July. Similarly, the eurozone's September trade surplus is old news. However, it is notable that Q3 was the first quarter in two years that a trade surplus was reported every month.

The euro had its best day of the year against the dollar, appreciating by 1.7%. It closed above the 200-day moving average for the first time since the end of August. The euro is consolidating in a narrow range mostly above $1.0845. The single currency met the (50%) retracement objective of the losses from the year's high (~$1.1275) near $1.0860. The next retracement (61.8%) is a cent higher. It was also sterling's strongest performance of the year, rising by a little more than 1.8% to push above $1.2500. It surged through the 200-day moving average (~$1.2440) and reached its best level since mid-September. It met the (38.2%) retracement of the losses since the July high (~$1.3140) found near $1.2460. The next retracement target (50%) is a little below $1.2600. Sterling is holding below $1.25 today and found some bids near $1.2445. 


October US CPI came in a little softer than expected, sending interest rates and the dollar broadly lower, while lifting stocks. The market feels more comfortable with its prior that the Fed's tightening cycle is over. Shelter prices, which account for around a third of the CPI basket, rose 0.3% last month, about half of the pace seen in September. Core service prices, excluding housing, are up 3.7% year-over-year, which is the lowest in a couple of years. Core goods prices fell for the fifth consecutive month. Through October, core goods prices are flat for the year after rising by about 3% in the first ten months of 2022.

US reports producer prices today, but the focus will be on retail sales. It is not good enough for price pressures to ease to boost confidence that inflation is moving toward the Fed's target, but demand needs to slow. Today's October retail sales report is expected to show just that. Retail sales rose at nearly an 8.5% annualized pace in Q3 and a 5.2% annualized increase in Q2. The median forecast in Bloomberg's survey is for a 0.3% decline, which would be the first since March.

Note that the December 2024 Fed funds futures implies an effective rate of about 4.43%. Currently, the effective average is 5.33%. This is to say that the market has 90 bp of cuts discounted by the end of next year. That is tantamount to three cuts fully priced in and about 60% of a fourth cut. The yield is about 26 bp lower than at the end of last week. This seems to be an exaggerated response to the modest miss on the CPI report. The futures market has around 80% of the first cut discounted for next May and two cuts by the end of July. It is difficult to envision the pendulum swinging more this direction.

The US dollar posted a bearish outside down day against the Canadian dollar, trading on both sides of Monday's range and settled well below its low. It extended yesterday's loss to slightly below CAD1.3880 before steadying. The greenback may be carving out a larger topping pattern against the Canadian dollar. A break of the CAD1.3600-30 area bolsters the case. The US dollar reversed lower at the end of last week from almost MXN17.94. It fell to almost MXN17.34 yesterday and briefly traded below MXN17.31 today. The low set earlier this month was about MXN17.2835. The double-top pattern forged last month projects toward MXN17.00. 


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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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