- U.S. yields continue to move higher; the jobs report is the highlight; October ISM services PMI came in soft; Canada highlight is also jobs data
- BOE hiked rates 75 bp to 3.0% but the forward guidance was very dovish; BOE tightening expectations need to adjust; final October eurozone services and composite PMI readings were firmer; Germany reported weak September factory orders; ECB tightening expectations have been pared back
- RBA released its Statement on Monetary Policy; reports suggest China is working on a plan to halt its Covid airline restrictions
The dollar is consolidating ahead of the jobs report. Some risk on impulses coming from China (see below) are boosting equity markets today. DXY ran into resistance above 113 yesterday and is currently trading near 112.50. Still, the recent break above 112.259 sets up a test of the October 21 high near 113.942. The euro remains heavy and is trading just below $0.98. It remains on track to test the October 21 low near $0.9705. Sterling has recouped some of its post-BOE losses (see below) and is trading just above $1.12. It remains on track to test the October 21 low $1.1060. The yen has held on to most of its recent gains and USD/JPY continues to have trouble trading much above 148. We think the uptrend remains intact but a break of 149.35 is needed to set up a test of the October 21 high cycle high near 152. The combination of ongoing risk off impulses and continued repricing of the Fed tightening path is likely to see the dollar continue to recover after this recent correction. Much will depend on the Fed and how the U.S. data come in but so far, the signs remain positive for the greenback.
U.S. yields continue to move higher. The 2-year yield traded at a new cycle high near 4.75% and is the highest since July 2007. The June 2006 high near 5.13% is the next big target, followed by the June 2006 high near 5.28%. The 10-year yield traded near 4.22% yesterday but has fallen to 4.14% today and remains below the October 21 cycle high near 4.34%. If the Fed continues to hike aggressively, we expect the 10-year yield to test of the June 2007 high near 5.32%. Looking ahead to the December 13-14 meeting, WIRP suggests a 50 bp hike is fully priced in with around 30% odds of a larger 75 bp move and that strikes us as too low. That will surely change before that meeting, as we will see two more sets of jobs, inflation, and retail sales reports and so that December decision will be truly data dependent. Fed officials will now go forth to spread the message. Collins is first up and speaks today.
The jobs report is the highlight. NFP consensus currently stand at 195k vs. 263k in September, while the unemployment rate is expected to rise a tick to 3.6% and average hourly earnings are expected at 4.7% y/y vs. 5.0% in September. We know that the labor market is a lagging indicator but the Fed is counting on seeing some weakness in order to help fight inflation. So far, the unemployment rate hasn’t been cooperating. Indeed, most labor force indicators continue to show resilience. Yesterdays, initial claims came in at 217k vs. 220k expected and a revised 218k (was 217k) the previous week.
October ISM services PMI came in soft. Headline came in at 54.4 vs. 55.3 expected and 56.7 in September. Employment came in 49.1 vs. 53.0 in September and activity came in at 55.7 vs. 59.1 in September. Prices paid rose to 70.7 vs. 68.7 in September, while supplier deliveries rose to 56.2 vs. 53.9 in September. Unlike the manufacturing sector, it appears the services sector is still seeing some supply chain issues and price pressures. Still, nothing in this report suggests Fed policy will be impacted. Of note, The Atlanta Fed’s GDPNow model is now tracking Q4 growth at 3.6% SAAR, up from 2.6% previously. Next model update is next Wednesday.
Canada highlight is also jobs data. Consensus sees 10.0k jobs added vs. 21.1k in September, with unemployment expected to rise a tick to 5.3%. October Ivey PMI will also be reported and stood at 59.5 in September. Last week, the Bank of Canada delivered a dovish surprise and hiked rates 50 bp to 3.75% vs. 75 bp expected. While it said that rates will need to rise further given high inflation, the shift was a surprise given how firm recent data have been. At his post-decision press conference, Governor Macklem said the bank “is still not there” in terms of ending its tightening cycle but added that it is getting closer to the end. WIRP suggests a 25 bp hike is fully priced in for the next meeting December 7 with around 65% odds of a larger 50 bp move, up from 30% at the start of this week. The swaps market is pricing in 50 bp of tightening over the next 6 months that would see the policy rate peak near 4.25%.
Bank of England hiked rates 75 bp to 3.0% but the forward guidance was very dovish. The MPC was once again split, with 9 voting for 75 bp, 1 (Dhingra) for 50 bp, and 1 (Tenreyro) for 25 bp. At the September 22 meeting, the MPC was also split, with 5 voting for 50 bp, 3 (Ramsden, Mann, and Haskel) for 75 bp, and 1 (Dhingra) for 25 bp. The bank said that the peak policy rate is likely to be lower than what’s priced in the markets and added that the economy is now in a recession that will persist through 2023. It also noted that no assumptions were made about the November 17 budget statement. This is all very dovish forward guidance, to say the least.
Recall that the swaps market had priced in a 4.75% peak right before the decision. This is down sharply from 6.25% right after the late September mini-budget as Chancellor Hunt came in and reversed course. It's still stuck at 4.75% now but it really should come off a bit. In his press conference , Bailey underscored that “We think bank rate will have to go up less than what’s currently priced into financial markets. That is important because, for instance, it means that the rates of new fixed-term mortgages should not need to rise as they have done.” When he leads with that, it’s going to be a bad day for sterling. After working hard to regain market confidence, the BOE goes and does this. Bailey added that the labor market is tight but signs of softening are emerging. Bailey stress ed that the forecasts show that the BOE should not hike rates too far.
BOE tightening expectations need to adjust. WIRP suggests nearly 80% odds of another 75 bp hike December 15. The swaps market is still pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 4.75%. This is down sharply from 6.25% right after the mini-budget in late September, but it seems that this should move even lower after the BOE decision. Chief Economist Pill speaks today and is likely to push the more dovish tone that was established yesterday.
Final October eurozone services and composite PMI readings were firmer. Headline services rose four ticks from the preliminary to 48.6, dragging headline composite up two ticks to 47.3. German composite rose a full point from the preliminary to 45.1, while France rose two ticks from the preliminary to 50.2. Italy and Spain reported for the first time and their composite PMIs came in at 45.8 and 48.0, respectively, both down from September. The sharp drop in Italy is noteworthy as the new government will likely struggle to submit a credible 2023 budget.
Germany reported weak September factory orders. Orders plunged -4.0% m/m vs. -0.5% expected and a revised -2.0% (was -2.4%) in August. As a result, the y/y rate came in at -10.8% vs. -7.2% expected and a revised -3.8% (was -4.1%) in August. Germany remains the weak link in the eurozone but the rest are already following it lower. With a big chunk of the eurozone already tipping into recession, can the ECB hike as aggressively as anticipated?
ECB tightening expectations have been pared back. WIRP suggests another 75 bp is about 50% priced in for December 15 vs. fully priced in after the October decision, while the swaps market is pricing in a peak policy rate between 3.0-3.25% vs. 3.5-3.75% after the October decision. There may be some relief to CPI in the months ahead after PPI decelerated in September to 41.9% y/y vs. 43.4% in August.
Reserve Bank of Australia released its Statement on Monetary Policy. The RBA warned that inflation is “too high” and that the labor market is “very tight.” Many of the macro forecasts were already revealed at the time of the decision to hike rates, but the full table helps fill out the picture. Growth was revised down, while inflation and unemployment were revised up. Of note, inflation is not seen returning to the 2-3% target range over the forecast horizon. All in all, the updated forecasts support the view that while the RBA may have downshifted to smaller hikes, the tightening cycle still has a ways to go. Of note, the swaps market sees the policy rate peaking near 4.30%. Australia also reported Q3 real retail sales at 0.2% q/q vs. 0.4% expected and a revised 1.0% (was 1.4%) in Q2.
Reports suggest China is working on a plan to halt its Covid airline restrictions. Currently, airlines are banned temporarily from specific routes into China for one to two weeks, depending on how many Covid-positive passengers are brought into China. The State Council reportedly asked government agencies recently to prepare for an end to the so-called circuit breaker mechanism. While we have expressed doubts about the rumored end to the Covid Zero policy that’s boosted mainland equities this week, perhaps there was this small grain of truth after all. Yet it’s quite a leap to go from ending airline restriction to ending Covid Zero altogether. Yes, it may ne step in the process but that process is likely to be long and drawn out.