Dollar Steadies Ahead of Retail Sales Data

November 15, 2023

Win Thin

We believe yesterday’s market reaction to the CPI data was overdone; financial conditions will continue to loosen; retail sales data will be very important; PPI will also be reported; a government shutdown has been averted
U.K. reported soft October CPI data; BOE easing expectations have picked up; eurozone reported soft September IP data; yet the latest E.U. forecasts see no recession on the horizon
Japan reported weak Q3 GDP data; Australia reported firm Q3 wage price index; all eyes will be on the meeting between Presidents Biden and Xi; China reported mixed October data

The dollar has steadied ahead of retail sales data. DXY is trading slightly higher near 104.170 after three straight down days. The euro is trading lower near $1.0860 while sterling is trading lower near $1.2465, both at levels not seen since early September. USD/JPY is trading flat near 150.40. With the dollar rally stalled, it will take some firm real sector data to challenge the current dovish Fed narrative. If the data do remain firm as we expect, the Fed doves (and the market) will eventually have to capitulate. We stress that the U.S. economy continues to grow above trend even as the rest of the world slips into recession, while price pressures remain persistent enough that the Fed may have to hike again and will not be able to cut rates as soon as the market thinks. That said, the dollar remains vulnerable until this happens.

AMERICAS

We believe yesterday’s market reaction to the CPI data was overdone. Does one data point really warrant a 22 bp drop in the 10-year yield? Or a -1.5% in DXY? The CPI data certainly fit the dovish Fed narrative but there are still miles and miles to go before the Fed can sleep easily. Before the next FOMC decision December 13, we will see whether November NFP, CPI, and PPI will confirm this narrative. That said, the dollar remains vulnerable to further near-term weakness.

October CPI data came in soft. Headline came in at 0.0% m/m and 3.2% y/y vs. 0.4% and 3.7% in September, respectively, while core came in at 0.2% m/m and 4.0% y/y vs. 0.3% and 4.1% in September, respectively. All the readings were a tick lower than expected and yet we’re not hanging up the "Mission Accomplished" banner just yet. Transportation was a big downside factor (-0.9% m/m). However, food and beverages (0.3%), housing (0.3%), and services (0.3%) are still showing solid m/m gains.

U.S. yields dropped sharply after the data. The 10-year yield traded as low as 4.43% yesterday, the lowest since September 22 before recovering to 4.47% currently, while the 30- year yield traded as low as 4.59% yesterday, the lowest since September 25 before recovering to 4.64% currently. Even the short end participated, as the 2-year yield traded as low as 4.81% yesterday, the lowest since November 3 before recovering to 4.85% currently.

Fed tightening expectations have evaporated. WIRP suggests 5% odds of a hike December 13. After that, it’s all about the cuts. Odds are over 80% of a rate cut May 1, with a total of four cuts priced in by end-2024. That isn't happening but the market sees what it wants to see. It's been wrong on the Fed this entire cycle. Given our more constructive view on the U.S. outlook, we believe market expectations for Fed easing will eventually be taken back. Barr and Barkin speak today.

Financial conditions will continue to loosen. With yields down and equities up last week, the Chicago Fed’s weekly financial conditions reading today should show further loosening. Given this week’s market movements, financial conditions are likely to get even looser. Recall that higher long-term rates were a major reason why many Fed officials felt that it had done enough tightening. The 10-year yield has fallen around 55 bp from the 5.02% peak in late October.

Retail sales data will be very important. Headline is expected at -0.3% m/m vs. 0.7% in September, while sales ex-auto are expected at -0.2% m/m vs. 0.6% in September. The so-called control group used for GDP calculations is expected at 0.2% m/m vs. 0.6% in September. September business inventories will also be reported and are expected at 0.4% m/m. The Atlanta Fed’s GDPNow model is tracking Q4 growth at 2.1% SAAR and will be updated today after the data. The New York Fed’s Nowcast model is tracking 2.5% SAAR growth and will be updated Friday.

PPI will also be reported. After the CPI fireworks, PPI is unlikely to have much market impact. Headline is expected at 1.9% y/y vs. 2.2% in September, while core is expected to remain steady at 2.7% y/y.

Regional Fed surveys for November start rolling out. Empire survey kicks things off today and is expected at -3.0 vs. -4.6 in October. New York Fed services survey will be reported Thursday. Philly Fed survey will also be reported Thursday and is expected at -8.3 vs. -9.0 in October. Kansas City Fed also reports Thursday and stood at -8 in October. Kansas City then reports its services index Friday and stood at -1 in October.

A government shutdown has been averted. At least, for now. Speaker Johnson’s two-step plan was passed last night by a 336-95 vote. Of note, 93 Republicans opposed it, but this was more than offset by the 209 Democrats who supported it. While reaching out to Democrats cost ex-Speaker McCarthy his post, hardliners in his party appear ready to give Johnson a pass, at least for now. The Senate is widely expected to pass it before the Friday deadline at midnight. Then comes the hard part, as 12 budget bills must be passed before parts of the government run out of funding January 19 and the rest run out February 2. Republican hardliners are fuming that steep spending cuts were not included in this bill.

EUROPE/MIDDLE EAST/AFRICA

U.K. reported soft October CPI data. Headline came in a tick lower than expected at 4.6% y/y vs. 6.7% in September, core came in a tick lower than expected at 5.7% y/y vs. 6.1% in September, and CPIH came in as expected at 4.7% y/y vs. 6.3% in September. Headline was the lowest since October 2021 but still above the 2% target. This is the first time that headline has been below the policy rate since 2016.

Bank of England easing expectations have picked up. WIRP now suggests less than 5% odds of a hike December 14, rising modestly to top out near 10% February 1. The first cut is now largely priced in for June 20 rather than August 1 previously. Last week, BOE Chief Economist Pill predicted that there would be a “sharp further fall” in October inflation to below 5% and added that market expectations for rate cuts by mid-2024 were not “totally unreasonable.” Haskel speaks later today and is likely to offer some hawkish comments. At the November 2 decision to hold, Greene, Mann, and Haskel dissented in favor of a 25 bp hike.

Eurozone reported soft September IP data. IP came in a tick lower than expected at -1.1% m/m vs. 0.6% in August, while the y/y rate came in at -6.9% vs. -6.3% expected and -5.1% in August. The data have been coming in soft lately and so ECB tightening expectations remain subdued. WIRP sees no odds of a hike December 14. After that, only cuts are priced and the first one is nearly 80% priced in for April 11 and fully priced in for June 6.

Yet the latest E.U. forecasts see no recession on the horizon. Q4 GDP is expected at 0.2% q/q vs. -0.1% in Q2. For all of 2023, growth is expected at 0.6% vs. 0.8% previously, while 2024 and 2025 growth are expected at 1.2% and 1.6%, respectively. While these forecasts are close to Bloomberg consensus, it’s hard for us to see how growth picks up so much in 2024. The ECB believes that much of the impact from past tightening has yet to be felt, which suggests rising headwinds well into next year.

ASIA

Japan reported weak Q3 GDP data. GDP came in at -0.5% q/q vs. -0.1% expected and 1.2% in Q2. This was the weakest reading since Q1 2022. Private consumption came in at 0.0% q/q vs. 0.3% expected and -0.6% in Q2, while business spending came in at -0.6% q/q vs. 0.1% expected and -1.0% in Q2. Both inventories and net exports subtracted from growth to the tune of -0.3 ppt and -0.1% ppt, respectively. The data will confirm the Bank of Japan’s concerns about removing accommodation too soon. WIRP suggests liftoff expectations are starting to get pushed out into June now.

Australia reported firm Q3 wage price index. It came in as expected at 1.3% q/q vs. 0.8% in Q2, while the y/y rate came in a ticker higher than expected at 4.0% vs. 3.6% in Q2. This is a new high for the cycle and reflects a labor market that remains relatively tight. No wonder the RBA remains ready to hike again. WIRP suggest no odds of another hike December 5 that rise over the course of H1 to top out near 40% in Q2.

All eyes will be on the meeting between Presidents Biden and Xi. It will take place on the sidelines of the APEC meeting in San Francisco. Topics to be discussed are too numerous to list here and we do not expect any major breakthroughs. However, the fact that the two are meeting at all is noteworthy and suggests a potential thaw in what has become a rather frosty relationship. Their last one-on-one meeting took in November 2022 in Bali.

China reported mixed October data. IP came in a tick higher than expected at 4.6% y/y vs. 4.5% in September, while sales came in at 7.6% y/y vs. 7.0% expected and 5.5% in September. Both FAI and property investment came in two ticks lower than expected at 2.9% YTD and -9.3% YTD, respectively. We do not think stimulus measures taken so far will have much lasting impact and so look for more in the coming months. PBOC kept its key 1-year MLF rate steady at 2.5% but offered a greater than expected CNY1.45 trln of liquidity to the system, the most in nearly seven years.

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