by Marc Chandler
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The Federal Reserve kicked off its easing cycle with a 50 bp rate cut on September 18. It is the seventh G10 central bank to cut rates this year. Japan is going in the other direction, albeit slowly. Norway's central bank says do not cut on a rate cut this year but be more confident of rate cuts next year. That leaves the Reserve Bank of Australia, which meets this week. It has been pushing against market speculation of a rate cut this year, and the market has gradually pared its aggressiveness. The Swiss and Swedish central bank also meet in the coming week. Both will most likely deliver their third quarter-point cut this year. Among a few emerging market central bank meetings, Mexico's stands out. It seems like a close call, but the swaps market has nearly 75 bp of cuts discounted with three meetings left this year.
The dollar fell against the G10 currencies last week except the Japanese yen and Swiss franc. The Dollar Index fell for the third consecutive week. In Q3, the Dollar Index has risen in only two weeks, declining in the other 10. Its technical tone is poor, but given the lighter economic calendar next week, consolidative phase seems more likely, especially if US rates continue to stabilize. Last week, the US two-year yield rose for the first time in three weeks (~six bp). It is a little below 3.65% having ended last month around 3.92%. The 10-year yield rose almost 11 bp last week to 3.76%. It was also the first weekly increase this month. It also captures the continued steepening of the yield curve. Lastly, by this time a week from now, Japan's Liberal Democratic Party will have a new leader, and therefore so will Japan. There are two immediate but interrelated questions that arise: Will she/he call for quick elections to secure a popular mandate? Will she/he try to influence monetary policy? We await developments.
United States: Whether the Federal Reserve delivers a 50 bp cut in six weeks is data dependent, even if not point dependent. The Fed's newest iteration of the dot plot has a median projection of 50 bp this year, while market has nearly 75 bp discounted. The reports in the coming days do not have the heft, to influence to influence the outcome very much, though some like the preliminary September PMI may have some headline risk. While durable goods may be an exception, it is a preliminary estimate of a volatile series. On the face of it, the personal income, consumption, and deflators are the most important. However, the deflators have little latest news outside of what the CPI and PPI told us. The headline rate will likely rise by 0.1% for a 2.3% year-over-year pace, down from 2.5% in July. The core may rise 0.2% (rounded up) for a 2.7% year-over-year rate after a 2.6% pace in July. Personal income and consumption still look solid and the Atlanta Fed's GDP tracker is at 2.9% for Q3, while the NY Fed's GDP tracker is at 2.6%.
The Dollar Index fell to a new low for the year (~100.20) after the FOMC decision to cut rates by 50 bp but the low close of the year was in late August (~100.50). It spiked to a five-session high the following day near 101.50. We suspect that near-term consolidation is likely. A close below 100.50 would be notable, while the upside may be capped ahead of 102.00, this month's high.
Japan: The LDP leadership contest will be resolved on September 2and result in a new prime minister of Japan. The LDP has dominated Japanese politics for nearly as long the Communist Party has governed China, and the Democratic Party has dominated Cook County and Chicago. The LDP's coalition partner, Komeito, will pick a new leader the next day. The main opposition party, the Constitutional Democratic Party selects its leader on September 23. The recognition of greater security threats and the enhanced military capability seems to have taken root in the LDP and a closer relationship with the US (and South Korea, Australia, and Taiwan). In terms of fiscal policy, there ae some differences LDP candidate but the outside they seem minor among the top candidates. Since the pandemic, the budget deficit has exceeded the current account surplus as a share of the economy. It is likely to return to its more traditional relationship, with the budget deficit smaller than the external surplus starting next year. The Bank of Japan is committed to normalizing monetary policy. Its tightening bias means that provided the economy and prices evolve broadly in line with its expectations, the BOJ will lift rates. The bar to another hike before the end of the year seems low and December looks more likely than October. The BOJ also has begun quantitative tightening by not replacing all the maturing bonds in its portfolio. The swaps market is pricing in a near doubling of the overnight rate from the current 0.25% in the next 12 months. In this context, the August services PPI and Tokyo's September CPI are the most important data points in the week ahead.
Broadly speaking, as go US 10-year rates so goes the dollar-yen exchange rate. While there is no need to overstate the case, we think the relationship is strong. The US 10-year yield bottomed the day before the FOMC near 3.60% and finished the week near 3.75%. The dollar bottomed against the yen at the start of last week (~JPY139.60) while Japanese markets were closed for a national holiday. They are closed again on Monday, September 23. A trendline connecting the mid-August and early September highs starts the new week near JPY145. That said, assuming US rates firm a bit more, the greenback may be able to recover toward JPY145.65.
Eurozone: The swaps market continues to hover around a 50% chance of a quarter-point hike at the next ECB meeting (October 17) and about a 60% chance of 50 bp increase by the end of the year. The data that the ECB says it is dependent probably does not give a large role to the preliminary PMI and other surveys out in the coming days. Some of the lending figures associated with the money supply release on September 26 may be of some interest. Yet, as the BOJ has a tightening bias, the ECB has an easing bias. The market is pricing in 125-150 bp of cuts by the middle of next year. Brandenburg, the third east German states that holds elections this month, goes to the polls on September 22. The AfD did well in the previous two states and is poised to do so in Brandenburg. However, the cordon sanataire prevents it from participating in state governments. The splinter party from The Left, known by the German acronym BSW (Reason and Justice Party) has been the surprise performer in these local elections and depending on how main parties do, its inclusion could become a path block the AfD, which could come in top place.
The euro set last week's range Wednesday and Thursday between about $1.1070 and $1.1185. The momentum indicators are constructive. The immediate hurdle is the year's high set in late August slightly above $1.12 and the 2023 high near $1.1275. A note of caution may be coming from the US-German two-year spread. The US premium has been declining. It fell for the five weeks from mid-August through mid-September, dropping around 30 bp to about 135 bp. The streak was snapped week and looks poised to consolidate. Initial support may be in the $1.1140-50 area. Only a break of $1.10 weakens the medium-term outlook.
China: Many Western critics do not seem likely to be satisfied unless and until China rejects the system that lifted its GDP per capita from the equivalent of about $315 to almost $3470 in 2008, and $10.1k on the eve of the pandemic. Still, even by Beijing's own goals, the economy is underperforming. Despite numerous efforts to stabilize the property market, the drag continues. The latest appears a possible cut in some $5 trillion in the interest rate of existing mortgages. Speculation of an 80 bp cut, which would produce a $40 bln reduction of the annual debt servicing costs. There has been some suggestion that it could be implemented in two steps. Past efforts have seemed to fail for being either too small, difficult to implement, or having to rely on less cooperative agents like the large banks. That said, this week offers the PBOC its first opportunity ease policy following the Fed's cut last week. The PBOC needs to add more liquidity into the banking system ahead of the extended holiday in early October and could chose to leave it after the holiday to ease financial conditions.
The yuan's apparent sensitivity to the movement of the yen and 10-year US rates appeared to slacken at the end of last week. The greenback fell to a new low for the year before the weekend near CNY7.0430 and CNY7.0385. The PBOC also set the dollar's reference rate almost 0.5% below the previous day, which is the biggest one-day change this year. The strength of the yuan could be creating more space for fresh stimulative initiatives by the PBOC and Beijing. The yuan has appreciated for around 0.6% against the dollar last week. It was the eighth weekly advance in the past nine weeks, which is its best run in four years.
UK: Although the Bank of England did not cut rates last week, the market remains confident of a least one more cut this year and a roughly two-thirds chance of two cuts with two meetings left for the year (November 7 and December 19). Data in the week ahead, which consists mostly of the preliminary September PMI estimate and revisions to Q2 GDP are unlikely alter expectations much. The base rate is at 5.0% and the swaps market anticipated it to be near 3.70% by the middle of next year. That is up from 3.55% a week ago.
The BOE sounded somewhat less than dovish and the stronger than expected August retail sales report may have helped lift sterling to a new two-year high before the weekend near $1.3340. The momentum indicators are trending higher, and the next technical target is in the $1.3500-$1.3650 area. Still, sterling is flirting with its upper Bollinger Band. A break of initial support near $1.3260 could signal a pullback toward $1.3170-$1.3200.
Sweden and Switzerland: The Riksbank meets on September 25. It has cut its policy rate by 50 bp in two moves this year (May and August). With inflation falling and weak economy, the market has fully discounted three more quarter-point rate cuts this year (September 25, November 7, and December 19). Over the next 12 months, the swaps market sees the target rate to be halved to about 1.75%. The krone has recovered from the record low a year ago against the euro. The euro is testing support near SEK11.30. A break signals a test on the SEK11.20 area. Against the dollar, the krona has recovered most of its earlier losses against the dollar and is off about 1.5% as of the end of last week. At its low (May 1), the krona was off more than 8.5% against the greenback. The Swiss National Bank meets the following day (September 26). It is widely expected to deliver its third quarter-point cut in the cycle that began in March. This new deposit will stand at 1.0%. The swaps market is pricing in nearly another 50 bp of cuts over the next 12 months. The euro rose for the second consecutive week against the Swiss franc and set a new high for the month before the weekend (~CHF0.9490). The euro may continue to outperform the franc, and we suspect there is potential back to the August high and 200-day moving average a little below CHF0.9600.
Australia: The Reserve Bank of Australia is the only G10 central bank outside of Japan and Norway that the market does not have a cut this year fully discounted. The central bank under Governor Bullock has repeatedly cautioned the market away from expecting a rate cut any time soon, but futures market is discounting about an 60% chance (down from around 85% at the end of the previous week). The RBA was among the last to tighten, and although it may be the last to cut, the market is discounting about 110 bp of cuts by the end of next year that would bring the cash target rate to 3.25%. The August monthly CPI print will be reported shortly after the central bank's decision is announced on September 24. The central bank puts put stock on the quarterly print but there has been virtually no improvement in the monthly estimate this year. It finished 2023 at 3.4% and was at 3.5% in August. The trimmed mean stood at 3.8% in July, the same as in January, though down from the 4.0% from last December. The central bank is concerned that demand, encouraged by the firm labor market, is still outstripping supply. Household spending on seasonally adjusted terms, rose at an annualized rate of 4% in the three months through July. Private credit growth, according to the RBA's measure rose at a 5.7% year-over-year pace in July. It has risen in all but one month since last November and its pace its strongest since May 2023. August retail sales will be reported on October 1. They also rose at an annualized rate of 4% in the three months through July. They were flat in the same three months last year.
The Australian dollar pulled back before the weekend but its nearly 1.5% gain last week led the G10 currencies. It stalled after appearing to match but not take out the year's high set in early January slightly shy of $0.6840. The momentum indicators suggest a top is not in place. The next band of resistance $0.6870-$0.6900.
Canada: The Bank of Canada has delivered three quarter-point cuts this year, making it among the most aggressive central banks. There are two meetings left this year (October 23 and December 11). The swaps market expected two more quarter-point cuts but sees the risk of a half-point move. The odds of a half-point move next month is slightly less than 50% and but it is nearly priced in before the end of the year. The main economic data point in the coming days is the July monthly GDP. The economy stagnated in June but appears to have performed better at the start of Q3. The continued moderation of price pressures, reported last week with the flat August CPI and continued decline in underlying measures is more important for market expectations than the monthly GDP print. The US 2-year yield has fallen about 30 bp since August 29. Canada's two-year yield has fallen by a little more. This resulted in a wider US premium over Canada. After peaking in June near 90 bp, it had fallen to less than 60 bp in late August and has recovered to 70 bp. Prime Minister Trudeau may face a no-confidence vote in the middle of the week. He will likely survive. The NDP is hoping for new concessions not a Conservative government.
While there have been some wide intraday swings, the US dollar has settled little changed on most sessions recently. In fact, there was only one session in the past seven that the greenback closed with more than a 0.1% change and that was last Thursday, the only session of the seven in which the greenback settled weaker. That illustrates how recently the US dollar rises slows but fall quick against the Canadian dollar. Unless the US dollar closes below CAD1.3550, the upside appears the path of least resistance. A retest on the month's high set last on September 19 around CAD1.3650 seems likely.
Mexico: The combination of the (aggressive) beginning of the US easing cycle, the recovery of the peso, the moderating price pressures, and softening economy, makes a rate cut this week a distinct possibility. Banxico has cut its overnight rate target twice this year (March and August). The swaps market is pricing in roughly 70 bp of cuts over the next three months. There are three meetings counting this week's in the remainder of the year (September 26, November 14, and December 19). There are nearly 250 bp of cuts discounted over the next 12 months. The peso was one of only a few currencies that did not get traction last week. In fact, leaving aside the special case of Russia, the peso was the weakest emerging market currency (while the yen was the weakest among the G10, off ~2.4% offering prima facie evidence that the carry-trade, either putting in or taking it off is not a driver now). The dollar appears to have forged a shelf around MXN19.06. The high for the week was set ahead of the weekend near MXN19.49. The momentum indicators look poised to turn up shortly. A move above MXN19.50 could spur near-term gains toward MXN19.60-MXN19.75.
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