Dollar Consolidates into the Weekend

October 25, 2024

Win Thin

The global divergence story remains intact; Fed officials have remained remarkably consistent in urging caution; Chicago Fed NAI came in soft; U.S. growth remains robust; Canada reports August retail sales
ECB officials continue to push back against dovish market expectations; German IFO survey for October showed modest improvement; ECB inflation expectations continue to fall; U.K.-German spreads have widened; BOE MPC member Mann stuck to her hawkish view
October Tokyo CPI data ran slightly hot; Governor Ueda signaled again that the BOJ is in no rush to remove policy accommodation; weekend elections in Japan could be a key driver for the yen; RBA Governor Bullock remains hawkish; New Zealand ANZ consumer confidence weakened

The dollar is consolidating into the weekend. DXY is trading flat near 104.051 after making at a new high for this move Wednesday near 104.570. It remains on track to test the July 30 high near 104.799. USD/JPY is trading higher near 152 ahead of weekend elections in Japan (see below), while the euro is trading flat near $1.0825 and sterling is trading higher near $1.2985. We believe that recent U.S. data and Fed comments continue to support a very gradual easing cycle. Market easing expectations for the Fed have adjusted after the recent spate of strong U.S. data but are still too dovish. As the Fed repricing continues, the dollar should see another leg higher after this period of consolidation. In the meantime, the weaker growth outlook for the rest of the world highlights the ongoing divergences that favor the greenback (see below).

AMERICAS

The global divergence story remains intact. Yesterday, S&P Global preliminary October PMIs for the U.S. came in strong. Manufacturing came in at 47.8 vs. 47.5 expected and 47.3 in September, while services came in at 55.3 vs. 55.0 expected and 55.2 in September. As a result, the composite rose to 54.3 vs. 53.8 expected and 54.0 in September. Contrast this with Japan, where its composite PMI delivering the biggest shock by falling below 50 to the lowest since November 2022. The U.K. also saw its composite PMI fall sharply to the lowest since last November, while the eurozone and Australian composites remained below 50 despite modest improvements. Will the U.S. continue to outperform? We say yes.

Fed officials have remained remarkably consistent in urging caution. Hammack said “We have made good progress, but inflation is still running above the FOMC’s 2% objective.” She pointed to geopolitical development and housing is risk factors that could put upward pressure on prices. Collins speaks today. At midnight tonight, the media blackout goes into effect and there will be no Fed speakers until Chair Powell’s press conference November 7.

September Chicago Fed National Activity Index came in soft. Headline came in at -0.28 vs. 0.50 expected and a revised -0.01 (was 0.12) in August. As a result, the 3-month moving average came in at -0.19 vs. a revised -0.14 (was -0.17), which remains well above the -0.70 threshold that typically signals recession.

U.S. growth remains robust. The Atlanta Fed’s GDPNow model is tracking Q3 growth at 3.4% SAAR and will be updated today after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q3 growth at 3.0% SAAR and Q4 growth at 2.6% SAAR and will also be updated today. Momentum in the economy remains strong and so a sharp slowdown is unlikely to be seen as we move into 2025.

Canada reports August retail sales. Statistics Canada’s advanced retail indicator suggests sales increased 0.5% m/m after rising 0.9% in July. Going forward, business surveys suggest sales growth will strengthen over the coming year but remain soft overall. The market is pricing in nearly 50% odds of another jumbo 50 bp cut in December.

EUROPE/MIDDLE EAST/AFRICA

European Central Bank officials continue to push back against dovish market expectations. Governing Council member Simkus said “As I read data, I don’t see a case for 50 bp cuts. What matters more than a single cut is where we’re going to.” GC member Vujcic said “I’m completely open to any discussion in December. Personally, I don’t know what the decision will be, nor I think we should know at the moment, because we should wait if we are data dependent, we should not now talk about 25 bp versus 50, or maybe a pause in December. Anything can happen depending on the incoming data.” The swaps market is pricing in 35% odds of a jumbo 50 bp cut in December, down from nearly 50% at the start of this week. Villeroy speaks later today.

German IFO survey for October showed modest improvement. Headline rose to 86.5 vs. 85.6 expected and 85.4 in September. This was the first improvement since May but remains far from that month’s cycle peak of 89.2. Both current assessment and expectations improved to 85.7 and 87.3, respectively. Despite the modest improvement, Germany remains the weak link in the eurozone. Indeed, IFO President Fuest noted that “In manufacturing, companies tell us the current situation has worsened, but they expect an improvement in the months to come. After four declines, this is a positive sign. But whether it’s a turnaround, we don’t know yet.”

ECB reported that September inflation expectations continue to fall. 1-year expectations fell two ticks more than expected to 2.4% vs. 2.7% in August and the lowest since September 2021, while 3-year expectations fell a tick more than expected to 2.1% vs. 2.3% in August and the lowest since February 2022. Easing inflation expectations leaves plenty of room for the ECB to keep cutting interest rates.

U.K.-German 10-year government bond yield spreads widened by over 10 bp this week to 197 bp, the highest since August 2023. Investors fear the U.K. Labour government will fund increased investment spending with higher debt issuance by tweaking budget rules to include government assets in the U.K.’s measure of debt. The greater risk premium on gilts is a drag on GBP and should push EUR/GBP higher. Chancellor of the Exchequer Reeves will present the budget on October 30.

BOE MPC member Mann stuck to her hawkish view. Mann cautioned “if you have structural persistence in the relationship between wages and price formation that lasts, that is persistent and embedded, then it’s premature to start cutting until you purge those behaviors.” Mann voted to hold the Bank Rate at 5.25% in August but was in the minority as the bank cut rates 25 bp then. Governor Andrew Bailey speaks today.

ASIA

October Tokyo CPI data ran slightly hot. Headline came in as expected at 1.8% y/y vs. 2.1% in September, but core (ex-fresh food) came in a tick higher than expected at 1.8% y/y vs. 2.0% in September and core ex-energy came in two ticks higher than expected at 1.8% y/y vs. 1.6% in September. Even so, Tokyo core CPI was the lowest since April and below the 2% target, which bodes well for the national CPI data.

Governor Kazuo Ueda signaled again that the BOJ is in no rush to remove policy accommodation. According to Ueda, there is “enough time” to examine economic data for making a policy decision and that financial markets remain unstable. He added that “We need to look at the whole picture, and need to diligently examine impacts on Japan’s inflation from not only a weak yen but a view on the US economy behind it - which may be related to the US presidential election.” The BOJ’s loose for longer policy stance should continue to undermine JPY.

Weekend elections in Japan could be a key driver for the yen. If the polls are correct and the LDP loses its majority in parliament, it will likely be more difficult for Prime Minister Ishiba to move forward with fiscal and monetary tightening. Some observers also believe that Ishiba will be severely weakened as LDP leader and may be challenged ahead of upper house elections scheduled for next year. Stay tuned.

RBA Governor Bullock remains hawkish. She reiterated in the foreword to the bank’s annual report that “it will take another year or two” before inflation returns “sustainably” to the 2-3% target range. Specifically, the RBA projects trimmed mean inflation at 2.9% in December 2025, 2.7% in June 2026, and 2.6% in December 2026. The market is pricing in just 25% odds of a 25 bp cut by December. We think the market is underpricing the risk the RBA starts easing by year-end, as 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. AUD is trading heavy as it tests the 200-day moving average near 0.6630 today. Looking ahead, break below 0.6575 sets up a test of the August low near 0.6350.

New Zealand ANZ consumer confidence weakened. Headline fell 4 points in October to a three-month low of 91.2. This was the first drop since June and was driven by declines in the current and future conditions indexes. Consumer confidence remains well below the 20-year average of 114.0, leaving plenty of room for the RBNZ to deliver additional jumbo rate cuts. The market has fully priced-in a 50 bp policy rate cut in November and implies a 24% probability of a larger 75 bp move. NZD is underperforming today and made fresh lows under 0.6000. It remains on track to test the August low near 0.5850.

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