• USD rally looks stretched. NFIB and weekly ADP employment take the spotlight.

• Jobs data the focus in the UK and Australia. Norway reports CPI.

• China monthly activity and credit data due. Peru to keep rates on hold.

Heads up: there will be no daily strategy report this week as I’m on the road. Publication will resume next week.

USD rallied last week before retracing part of its gains after testing resistance at the 200-day moving average. 2-year Treasury yields dipped slightly, and US stocks faced selling pressure. US economic data released last week was decent overall, but concerns over lofty US equity valuation dominated the market narrative.

Too Far Gone

In our view, USD will struggle to gain additional upside traction in part because the recent widening in US-G6 2-year bond yield spreads has run its course. Fed policy is still restrictive and leaves scope for the Fed to deliver more easing. In contrast, most other major central banks have reached neutral policy settings.

The ECB, Riksbank, BOC, and RBA signaled they’ve completed their cutting phase and others (Norges Bank and SNB) are nearly done easing. Only a couple of G10 central banks (BOE and RBNZ) still have more rate cuts in the pipeline while the BOJ is the outlier with a hiking bias. US October NFIB small business optimism index and weekly ADP jobs print (both on Tuesday) are the only data releases amid the ongoing government shutdown.

Liquidity Normalizes

US liquidity conditions are back to normal after seizing up briefly late last month. The spread between the tri-party general collateral rate (TGCR) and interest rate on reserve balances (IORB) has tightened back to nearly 0bps after overshooting to +25bps on October 31. In normal conditions, TGCR should be close to or slightly below IORB on average over time.

Upward pressure on funding rates in recent months reflects temporary factors related in part to fiscal flows and the US Treasury’s growing cash balance at the New York Fed (TGA balance) due to the government shutdown. My colleague Jorge Aseff, Portfolio Manager Inflation-Indexed Fixed Income, points out that while we can see further brief jumps in the funding market in the near term, the situation is not alarming.

We agree. First, the Fed will end the reduction of its aggregate securities holdings (quantitative tightening) on December 1, ensuring that reserves remain ample. Second, the Fed has established strong tools (the discount window and Standing Repo Facility) to put a ceiling on money market rates and to provide additional liquidity if needed.

UK: Jobs and GDP on Deck

UK September labor market report (Tuesday) and Q3 GDP (Thursday) to leave room for the Bank of England (BOE) to cut rates in December. The unemployment rate is forecast at 4.9% vs. 4.8% in August consistent with a further loosening in the labor market. Meanwhile, slower wage growth reduces upside risks to inflation. Total regular pay is expected at 4.6% y/y (lowest since April 2022) vs. 4.7% in August, and private sector regular pay is projected at 4.2% y/y (matching the December 2021 low) vs. 4.4% in August.

The BOE forecasts Q3 real GDP at just 0.2% q/q vs. 0.3% in Q2, reflecting weak growth in exports to the US, and disruption linked to the Jaguar Land Rover cyberattack. The BOE expects real GDP growth to pick up to 0.3% q/q in Q4 but the upcoming Autumn Budget (due November 26) risk weighing on growth. To plug a fiscal hole as big as £35 billion, the UK government is seen prioritizing tax hikes over spending cuts.

The UK swaps curve implies 70% odds of a 25bps rate cut to 3.75% at the next December 18 meeting and a total of 60bps of easing in the next 12 months. The risk is the BOE delivers more easing than is currently priced in given the anticipated fiscal drag. Bottom line: we expect GBP to keep underperforming on the crosses.

No Rush BOJ

The Bank of Japan’s (BOJ) Summary of Opinions for the October 29-30 meeting (Sunday) will likely echo the bank’s ongoing patience with policy normalization. At that meeting, the BOJ kept the policy rate at 0.50% (90% priced-in) in a 7-2 majority vote. Like at the last September meeting, BOJ members Takata Hajime and Tamura Naoki, favored a 25bps hike to 0.75%.

Overall, there’s no strong indication that the BOJ is in a hurry to resume normalizing rates which remains a drag on JPY. The swaps market continues to see even odds of a December rate hike, with a full 25bps move priced in over Q1.

RBA Steady Call Faces Test

Australia’s October labor force survey (Wednesday) to reinforce the RBA’s steady bias. The economy is projected to add 20k jobs vs. 14.9k in September and the unemployment rate is seen at 4.4% vs. 4.5% in September, in line with the RBA’s forecast. According to the RBA, leading indicators continue to point to a broadly stable near-term outlook for labor market conditions.

Bottom line: the RBA is well positioned to keep rates on hold as it works to bring runaway inflation back within its 2-3% range. Cash rate futures continue to price in one 25bps cut over the next 12 months and rates to bottom at 3.35%. As such, there is room for rate expectations to adjust higher in favor of AUD.

Norway CPI in Focus

Norway October CPI print (Monday) to back the Norges Bank’s cautious cycle. Headline inflation is expected at 3.0% y/y (Norges Bank forecast: 2.7%) vs. 3.6% in September while underlying inflation is expected at 3.0% y/y (Norges Bank forecast: 3.2%) vs. 3.0% in September.

The Norges Bank kept the policy rate at 4.00% (fully priced) last week and reiterated that “the policy rate will be reduced further in the course of the coming year.” The Norges Bank also stressed that “a restrictive monetary policy is still needed” because inflation is still too high.

The Norges Bank has penciled in one 25bps cut in the next 12 months while the swaps market implies 40bps of easing. In our view, persistently above target inflation backs the Norges Bank’s prudent monetary policy easing stance and is NOK supportive.

China Growth Blues

China’s October CPI picks-ups on holiday demand. Headline CPI unexpectedly quickens at the fastest pace since January to 0.2% y/y (consensus: -0.1%) vs. -0.3% in September and core CPI rose to 1.2% y/y vs. 1.0% in September, matching the February 2024 high. PPI printed at -2.1% y/y (consensus: -2.2%) vs. -2.3% in September and still suggests that deflationary pressure remains high.

China’s benign inflation backdrop continues to suggest that consumption spending is too weak. The activity and credit data for October due out this week are expected to point to a soggy growth backdrop. In our view, a gradual revaluation of China’s currency could help China stimulate consumer spending by boosting disposable income through cheaper imports. Bottom line: USD/CNH has room to break lower.

BCRP to Stand Pat

Peru central bank (BCRP) is expected to keep the policy rate at 4.25% for a second straight meeting (Thursday). Core CPI and one-year-ahead inflation expectations are near the middle of the bank’s 1 to 3% target range and the BCRP assesses the current interest rate level to be “very close to the level estimated as neutral”. Peru’s positive real interest rates, favorable balance of payments backdrop, and firm copper prices continue to underpin the uptrend in PEN vs. USD.