Technical Pullback Underway

• USD and Treasury yields pared back some of their solid gains. The fundamental backdrop still favors higher Treasury yields and USD strength.

• The spotlight today is on relative growth momentum with the release of the October PMI readings for the EU, UK, and US.

• RBNZ, BOC, ECB, and BOE officials are sounding cautious on the pace of rate cuts.

USD and Treasury yields pared back some of their solid gains. This looks more like a technical pullback. The fundamental backdrop, reflected by U.S. economic outperformance, continues to favor higher Treasury yields and USD strength.

The October Fed Beige Book was mixed. According to the Beige Book “On balance, economic activity was little changed in nearly all Districts since early September, though two Districts reported modest growth…Despite elevated uncertainty, contacts were somewhat more optimistic about the longer-term outlook.”

The U.S. October preliminary PMIs are forecast to remain indicative of an encouraging growth outlook (2:45pm London). The composite PMI is forecast to dip 0.2pts to 53.8. Manufacturing is expected to rise 0.2pts to 47.5 and services is projected to drop 0.2pts to 55.0.

EUR/USD is firmer near 1.0790 after testing multi-month lows around 1.0760 yesterday. Key ECB officials continue to temper expectations of a steeper easing cycle. President Lagarde reiterated that rate cuts “should be continued with that caution element about it.” Lane noted that while there was “high conviction that the disinflation process is well on track”, the Eurozone economy isn’t showing signs of “dramatic weakening.” Holzmann said “a quarter-point step is probable in December…A bigger half-point cut is unlikely though not impossible.” A few other ECB officials are more dovish. Centeno said the ECB is probably behind the curve and should consider steeper rate cuts while Panetta warned the ECB cannot exclude lowering the policy rate below neutral.

The Eurozone September preliminary PMIs are forecast to remain consistent with soggy economic activity (9:00am London). The composite PMI is forecast to rise 0.1pts to 49.7. Manufacturing and services are expected to increase 0.1pts to 45.1 and 51.5, respectively. France and Germany’s PMIs are released earlier (8:15am and 8:30am London, respectively).

GBP/USD firmed up slightly on USD weakness, but GBP is underperforming against most other major currencies. Bank of England Governor Andrew Bailey’ comments yesterday were surprisingly balanced as he did not hint at more aggressive rate cuts like he did earlier this month.

Bailey acknowledged that “disinflation is happening I think faster than we expected it to, but we have still genuine question marks about whether there have been some structural changes in the economy.” Bailey also warned that services inflation (4.9% y/y in September) is still higher than consistent with target and the labor market, was “probably loosening,” but still tight. Governor Bailey speaks again later today (8:45pm London) and BOE MPC member Catherine Mann takes part in a panel discussion (2:00pm London).

The U.K. October preliminary PMIs should reinforce the case for a cautious BOE easing cycle and offer GBP additional support (9:30am London). The composite PMI is forecast to dip 0.1pts to 52.5. Manufacturing and services are expected to remain unchanged at 51.5 and 52.4, respectively.

USD/JPY is range-bound near recent highs around 148.50. Japan’s finance minister Kato stuck to the government’s well-honed currency script warning “We are seeing one-sided, rapid moves…We will closely monitor the foreign exchange market with a stronger sense of urgency, including watching for speculative trading.”

Regardless, the Bank of Japan (BOJ) loose for longer policy stance remains a drag for JPY. Japan private sector activity fell into contraction in October suggesting the BOJ will not take a more hawkish tone at next week’s meeting. The composite PMI dropped sharply to a four-month low at 49.4 vs. 52.0 in September. Manufacturing fell to 49.0 vs. 49.7 in September and services plunged to 49.3 vs. 53.1 in September.

AUD/USD rebounded after finding support at the 200-day moving average (0.6629). Australia’s flash October PMIs points to a stabilization in business activity. The composite PMI recovered to a 2-month high at 49.8 vs. 49.6 in September as services sector activity improved to 50.6 vs. 50.5 in September. In contrast, the contraction in the manufacturing sector deepened slightly to a 53-month low at 46.6 vs. 46.7 in September. We expect the RBA to join the global easing cycle later this year because Australia underlying economic activity is weak and points to lower inflation pressures. Next week’s Q3 CPI report will either support our view or ensure the RBA continues to lag its international peer.

NZD/USD retraced some of its recent sharp losses. RBNZ Governor Orr managed expectations for more aggressive policy rate cuts. Orr noted that policy will remain on the restrictive side “over the coming quarters as we get more and more confident that pricing behavior has renormalized.” Orr added that “on the way down we can be more incremental..because we’re in calmer waters but also because of that lingering inflation persistence on the domestic side.”

The swaps market responded quickly to Orr’s speech, with odds of a 75 bp cut in November falling to 24% from around 40%. Overall, the RBNZ has plenty of room to continue easing as the policy rate (4.75%) is still well above the RBNZ’s estimate for the nominal neutral rate range of 2-4%.

USD/CAD is down near 1.3820 on USD weakness. Yesterday, USD/CAD had a kneejerk uptick above 1.3860 after the Bank of Canada (BOC) delivered on expectations and slashed the policy rate 50 bp to 3.75%. Governor Macklem confirmed there was a “clear consensus” for a 50 bp cut. Importantly, more easing is in the pipeline as the BOC highlighted “we anticipate cutting our policy rate further.”

The BOC inflation outlook was neutral and argues for a cautious easing cycle. The BOC forecasts inflation will remain close to the 2% target over the projection horizon and sees upward and downward risks to its inflation projection as “reasonably balanced.” Nevertheless, the BOC has plenty of room to cut rates further which can continue to undermine CAD. Policy is still too tight and a downside risk to Canadian economic growth. At 3.75%, the BOC policy rate remains above the bank’s nominal neutral interest rate estimate of 2.25% to 3.25%.