by Marc Chandler
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There are powerful forces in the capital markets, and they do not appear exhausted even if there is some near-term consolidation. The Dollar Index has risen for seven weeks, which is to say that it has not fallen on a weekly basis so far here in Q4. The US two-year yield has risen for the past four weeks and six of the past seven. It has surged from about 3.55% at the end of September to 4.38% last week. The US 10-year yield has fallen in only two weeks since mid-September. It reached 4.50% at the end of last week, up from 3.65% on September 13. Yet, the change in inflation expectations accounts for a small part of the rate adjustment. The 10-year breakeven accounts for only about 25 bp of that 95 increase. It looks like another 25 bp or so can be accounted for by the change in expectations for Fed funds. There is also a supply premium in anticipation of larger deficits and more debt. In addition, there some risk of a downgrade next year. S&P and Fitch sees the US as a AA+ credit. Moody's gives it the equivalent of AAA with a negative outlook.
G10 central bank meetings are over until next month. China will have an opportunity to reduce rates in the coming days, but it is too soon to expect officials to deliver more rate cuts. The UK and Canada report October CPI. At stake is whether the Bank of Canada cuts rates by another 50 bp next month or slows to 25 bp. It may take a shockingly weak CPI to resuscitate hopes of a Bank of England rate cut at its December meeting. Also, due at the end of next week is the preliminary November PMI. It appears to typically have the most impact in Europe. Investors will be monitoring the nominations by the new US administration, and several senior posts, including the secretaries of the Treasury and Commerce and the US trade representative have yet to be made.
United States: There are two considerations shaping the investment climate. The first is the trajectory of Fed policy, and the data in the coming week, mostly survey and housing starts and permits, tend not to be decisive. The weekly jobs claims cover the same week as monthly survey and could be somewhat more important. The futures market discount about a 62% chance of a quarter-point cut at next month's FOMC meeting which will also update the Summary of Economic Projections, which is slightly lower than a week ago. The market is pricing almost 75 bp of cuts between now and the end of next year. Before the election, there were about 85 bp on top of the quarter-point cut that was delivered last Thursday. The second consideration is the airing of potential appointments in the next administration to glean insight into policy priorities and interests. There are several pro-growth elements but there are also some measures, like tariffs, which seem less supportive, especially in the near- and intermediate terms.
The Dollar Index poked above 107.00 for the first time since October 2023 on November 14 before consolidating ahead of the weekend. The 2023 high was slightly below 107.40, and a move above there could target the 109.00 area. Initial support is now seen in the 106.20-40 area, and then 105.65. The Dollar Index gapped higher on November 6 and has not looking back. A close below the five-day moving average (~106.25) could be among the first signs that the rally is faltering.
Eurozone: The economic highlight in the week ahead is the preliminary November PMI. Recall that the after dipping below 50 in September for the first time since February, the eurozone composite PMI returned to 50 in October. The market is more confident that the ECB cuts rates next month than the Federal Reserve or the Bank of England. Moreover, swaps market is pricing in a greater chance that the ECB cuts rates by 50 bp than stand pat. Despite lack of strong political leadership among most of the large members of the bloc, the tensions reflected by the interest rate differentials are relatively subdued. Meanwhile, the US two-year premium over Germany widened through last year's high to around 225 bp. This coupled with euro's five-day moving average trading below the 20-day moving average warns that euro's decline may not have been exhausted.
Still, the 4.4-cent sell-off since US election is extreme, and the downside momentum slackened ahead of the weekend. In fact, Friday was the first session in six that the euro did not trade below the previous session's low. However, the upticks have not been inspiring and the settlement was poor. The $1.06 area has capped upticks since the 2024 low was set slightly below $1.05 on November 14. Above $1.06, initial resistance is likely around $1.0620, but we expect it to test the 2023 low near $1.0450 in the coming days.
Japan: Japan has its first minority government. The LDP's Ishiba remains prime minister though neither the LDP alone, nor with its traditional coalition partner, the Komeito Party, has a majority of seats in the lower chamber of the Diet. The opposition parties could not agree on an alternative, leaving the LDP in charge, even if in a more limited way. The next immediate focus is the supplemental budget, and while there may be some negotiations over particulars, it will likely be widely agreed upon. Other elements of the LDP agenda, including tax increases to be for the enhanced defense capabilities may prove more controversial. The swaps market has discounted between around five and 12 bp of hikes for next month's BOJ meeting in the past several weeks and currently is in the upper end of the range, perhaps encouraged by the yen's weakness. By the middle of next year, the swaps market discounted almost 32 bp tightening will be delivered. That is about 10 bp more than a month ago. Japan reports its October trade balance on November 20. It may be a useful reminder to the transition team in Washington, that despite the yen's weakness, Japan runs a trade deficit. Through September, the trade deficit this year is about JPY4.9 trillion (~$32.5 bln). Japan runs a current account surplus, which reach 4% of GDP this year. It is driven by past investments in foreign bonds, stocks, plant and equipment, as well as royalties, licensing fees, and the like. At the end of the week, Japan sees the October CPI and the preliminary PMI. The markets do not typically respond much to Japan's PMI, and the CPI signal was already delivered by the Tokyo report on October 25. We know that headline and core CPI softened primarily to energy subsidies, and excluding both fresh food and energy, Tokyo's CPI crept higher. The national measure runs a little hotter than Tokyo's CPI, but it could ease to 2.2%-2.3% from 2.5% in September. The core may moderate to 2.2% from 2.4%, while the measure could tick up to 2.3% from 2.1%.
The dollar reached JPY156.75 ahead of the weekend, its best level since July 23 before it reversed and fell to nearly JPY153.85. It traded on both sides of the previous session's range and settled well below Thursday's low to post a key reversal. The greenback snapped a four-day advance but settled higher for the sixth week in the past seven. Follow-through selling early next week could test support near JPY153.35. The 20-day moving average is a little lower (~JPY153.10), and the dollar has not settled below it since late September.
China: Investors were disappointed by the absence of bolder initiatives from the National People's Congress. Its biggest achievement seemed to have been providing some color to a program announced last month for local governments' debt swap (CNY10 trillion, ~$1.4 trillion) that is to run through 2028. Nor were investors impressed with October real sector data reported ahead of the weekend. The CSI 300 was among the weakest of the large equity markets, dropping 1.75% before the weekend, which was nearly half of last week's loss. Some suggest that the lack of fresh fiscal action is to provide Beijing room to maneuver and respond to actions by the new US administration. In any event, it is too soon to expect the one-year Medium-Term Lending Facility Rate, or the loan prime rates will be cut in the coming days.
The dollar appreciated by about 2.50% against the offshore yuan since the US election. It reached about CNH7.2665 on November 14 and consolidated ahead of the weekend. It eased to almost CNH7.23. Support is seen around CNH7.21. The PBOC had been setting the dollar's reference rate near market expectations (like the Bloomberg survey), but this changed in the middle of last week. The dollar's fix was set considerable higher than expected which, counter-intuitively limits the scope for dollar appreciation/yuan weakness as the exchange rate is allowed to deviate by from the reference rate by 2%, which the market rarely explores.
United Kingdom: Speculation of a December BOE rate cut has been scaled back. This week, the UK reports one of two inflation reports that officials will see before next month's MPC meeting. It is unlikely to persuade the market otherwise and the base effect warns that when this month's CPI is reported the day before the December19 meeting, it may be running somewhat higher than it is now. The UK's CPI was flat in October 2023 and fell by 0.2% in November 2023. Indeed, by the time the BOE meets next month, the year-over-year rate could be back at or slightly above 2% compared with 1.7% September. The core rate stood at 3.2% in September, while consumer service prices were up 4.9% year-over-year. The UK reports October retail sales on November 22. UK consumption was strong in Q3, rising 1%, and retail sales rose by an average of 0.8% a month after averaging only 0.1% a month the first half. Shortly after the retail sales, the preliminary November PMI will be announced. The composite slipped in September and October to 51.8 and has not been below 50 since last October.
Sterling still cannot sustain an uptick. It has fallen for the past six sessions. On a weekly basis, it has not risen since the end of September. It has depreciated by nearly 6% since the end of Q3 and a little more than half has been recorded since the US election. It took out the June-July low near $1.2615 and slipped below $1.2600 in late North American dealings before the weekend. Below there, support may be around $1.2450-$1.2500, though the year's low from April was around $1.2300. On the upside, the $1.2700-20 area provides the nearby cap.
Canada: Canada's CPI fell at an annualized rate of nearly 1% over the four months through September. It reports October's CPI on November 19. The underlying core measures also have been gradually trending lower. At stake is the December 12 rate decision by the Bank of Canada. Recall June-September, the Bank of Canada cut the overnight lending rate three times by a total of 75 bp, and then, its October delivered a 50 bp cut. The target rate is 3.75%. The swaps market has a little more than a 50% chance of another half-point cut discounted. Canada's September retail sales are released at the end of the week. They rose by 0.9% in July and 0.4% in August for the best two months of the year. StatsCan indicated recently that the receipts from retailer rose by another 0.4% in October.
The Canadian dollar was one of the best performers among the G10 currencies in past week and it still lost most than 1% to fall to a new low since the pandemic. It will begin the new week with a six-session decline in tow. Overcoming CAD1.41 targets CAD1.42. The Covid high was near CAD1.4670. The US dollar settled above its upper Bollinger Band for the second consecutive session ahead of the weekend. The benchmark three-month implied volatility has move to the upper end of its recent range near 5.6%. It has not been above there since April, and the high for the year was set in January slightly below 6%. Meanwhile, the US two-year premium over Canada has risen for the past seven weeks. It was near 65 bp at the end of Q3 and is now almost 118 bp, the most since 1997.
Australia: There are two highlights in the week ahead. First, early Tuesday, the minutes from this month's central bank meeting will be published. They tend not to be market-movers. While any lingering threat of a rate hike has diminished, officials have persuaded the market that policy will be on hold for some time. Specifically, the futures market has a 60% chance of a cut discounted for April 2025, and the first cut is not fully priced until May. The other highlight is the preliminary November PMI. The composite has been alternating between advances and declines for the past four month, straddling the 50 level. It was 50.2 in October. The Australian dollar also has fallen for the past six sessions, shedding 3.6% in the course of the drop. The year's high was recorded in late September near $0.6940. At the end of last week, it approached $0.6440. The year's low was in early August around $0.6350. The Aussie settled below its lower Bollinger Band for the past two sessions, and although the momentum indicators are stretched, a bottom does not seem to be in place. Resistance now is likely $0.6480-$0.6500.
Mexico: The dollar put in a high against the Mexican peso on November 6 near MXN20.8070. Last week's high was slightly below MXN20.70. A consolidative tone emerged after a firmer start to the week. Still, the tone is fragile. The JP Morgan Emerging Market Currency Index fell 1.2% last week, the most in four months. The nearly 5% decline in the MSCI Emerging Markets equity index was the most since June 2022. In a unanimous decision, Banxico delivered its fourth quarter-point cut of the year and brought the overnight rate to 10.25%. It is instructive that the central bank cut rates despite the peso's weakness and the uptick in the headline CPI, apparently finding comfort in the continued decline of the core rate. Banxico meets next on December 19, a day after the FOMC meeting concludes. At the end of the week, Mexico reports the first half of November CPI but ahead of next month's central bank meeting, the November CPI will be released (December 9). A softer core CPI and a Fed cut would likely encourage Banxico to cut again. Brazilian markets were closed for a national holiday before the weekend. The greenback ended a five-day advance on November 14 with a miniscule loss. It frayed the BRL5.80 level but has been unable to settle above it since November 1.
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