- October U.S data remain strong; the U.S. economy is rebounding nicely in Q4; announcement of the next Fed Chair is not as imminent as previously advertised; Canada reports October CPI
- ECB asset purchases remain fairly elevated; ECB published its Financial Stability Review and warned of several risks; U.K. reported higher than expected October CPI; Brexit tensions continue to simmer; TRY continues to weaken as President Erdogan pushes for lower interest rates
- Japan reported soft October trade and September core machine orders data; crypto assets continue to correct with Bitcoin dipping back below the $60K level
The dollar continues to power higher. DXY traded today at a new cycle high near 96.241 before dropping back a bit during the European morning. We look for further gains and suddenly, the June 2020 high near 97.802 doesn’t look so far away. Similarly, the euro traded at a new low today near $1.1265 but has since resurfaced above $1.13. Here, he next major chart point is the June 2020 low near $1.1170. Sterling is holding up on firm U.K. CPI data (see below). Despite the support seen all week near $1.34, we believe it remains on track to test the December 2020 low near $1.3135. USD/JPY is finally playing catch-up after struggling to make headway above 114. The pair traded just shy of 115 and the break above last month's high near 114.70 sets up a test of the December 2016 high near 118.65. The fundamental backdrop continues to favor the dollar.
It’s no mystery that the stronger dollar cycle is the main driving force behind EM’s under performance. However, the question remains as to whether EM can decouple at some point. The answer is that it has, to some degree, if looked at from a regional perspective. Asian currencies have seen only minor weakness over the last few months, with the local currency index down only about 1% year to date. In comparison, its Latin American counterpart is down 8% this year. The inevitable conclusion here is that rate hikes in Latam were not enough to offset the weaker economic picture and elevated political risk premium (see below) for the region. At this point, we don’t see this changing.
October U.S data remain strong. Headline retail sales rose 1.7% m/m vs. 1.4% expected and a revised 0.8% (was 0.7%) in September, while sales ex-autos rose 1.7% m/m vs. 1.0% expected and a revised 0.7% (was 0.8%) in September. The so-called control group used for GDP calculations rose 1.6% m/m vs. 0.9% expected and a revised 0.5% (was 0.8%) in September. Last week, University of Michigan consumer sentiment fell to 66.8, a 10-year low. Yet it’s clear that this weak sentiment has not weighed on consumption, with retail sales posting big upside surprises for three straight months now. One word of warning: these are nominal measures and so the gains are partially due to higher prices (inflation). GDP data strip out the inflation to get real growth but still, consumption seems robust. Elsewhere, October IP rose 1.6% m/ vs. 0.9% expected and -0.7% in September.
The U.S. economy is rebounding nicely in Q4. The Atlanta Fed’s GDPNow model is tracking 8.7% SAAR growth, up from 8.2% before the retail sales data and well above the 2.0% posted for Q3. There will be another update today after October building permits (2.8% m/m expected) and housing starts (1.6% m/m expected) are reported. Elsewhere, Bloomberg consensus sees 4.8% SAAR growth in Q4, slowing to 4.2% in Q1 and 3.9% in Q2.
It appears that the announcement of the next Fed Chair is not as imminent as previously advertised. President Biden said yesterday that his choice will be revealed “in the next four days.” Biden confirmed that it’s basically down to Powell and Brainard, and Senate Banking Committee Chair Brown said he has no doubt that either one would be confirmed. We will repeat our long-standing belief that Powell should be appointed to a second term. While the policy differences between the two are likely minimal, Powell is battle-tested and has earned the confidence and respect of the market. We are still in the midst of the pandemic and it would not be wise to change horses mid-stream, as the saying goes.
Yesterday, Bullard called for the Fed to tilt more hawkish due to rising inflation risks. He said “I think it behooves the committee to go in a more hawkish direction in the next couple of meetings so we are managing the risk of inflation appropriately,” which implies that the Fed should speed up tapering that just began this week at a pace of $10 bln UST and $5 bln MBS per month. While the Fed reserved the right to adjust the pace, it seems way too soon to talk about changing it and we believe the bar to any change is fairly high. Bullard has been the most hawkish and has said that he has penciled in two hikes for 2022. The September Dot Plots suggest two other Fed officials thought likewise. Six saw only one hike and nine saw no hike, but we suspect this will drift more hawkish in the December Dots. Williams, Bowman, Mester, Waller, Daly, Evans, and Bostic all speak today.
Canada reports October CPI. Headline inflation is expected to pick up three ticks to 4.7% y/y, while common core is expected to pick up a tick to 1.9% y/y. If so, headline would be the highest since February 2003 and further above the 1-3% target range. Bank of Canada liftoff expectations remain elevated. WIRP suggests 50-50 odds of a hike January 26, moving up to fully priced in March 2. This seems too aggressive to us and yet Governor Macklem has so far not pushed back against market expectations. Next policy meeting is December 8 and we look for further clarity then.
Chile President Pinera survived an impeachment motion which received only 24 of the necessary 29 votes to pass. Pinera is being accused of conflict of interest in his family’s sale of a mining project after documents emerged from the Pandora Papers. This story may not end here, however, as investigations are still ongoing. All of this is happening towards the end of his term, with elections scheduled for Sunday. Jose Antonio Kast (right-wing) and Gabriel Boric (left-wing) are likely to advance to the second round. The peso sold off sharply yesterday by about 1.5%, but happened against the background of broad EM weakness and dollar strength.
ECB asset purchases remain fairly elevated. Net purchases for the week ending November 12 came in at EUR18.3 bln. A “moderately lower pace” for Q4 was announced September 9 and net purchases have averaged between EUR15-16 bln per week since the summer, down “moderately” from the EUR20 bln average after accelerated purchases were announced March 11. Next ECB meeting December 16 should see some sort of extension of QE, as we believe the risks of removing accommodation are rising significantly. Schnabel speaks today.
The ECB published its Financial Stability Review and warned of several risks. These risks consist of the usual suspects, which include stretched valuations in property and financial assets as well as elevated risk-taking and borrowing. Specifically, the ECB noted “Concerns particularly relate to pockets of exuberance in credit, asset and housing markets, as well as higher debt levels in the corporate and public sectors as a legacy of the pandemic.” It added that “The markets for equity and risky assets have maintained their striking buoyancy, making them more susceptible to corrections. There have been examples of established market players exploring more novel and more exotic investments. In parallel, euro-area housing markets have expanded rapidly, with little indication that lending standards are tightening in response.”
U.K. reported higher than expected October CPI. Headline inflation surged 4.2% y/y vs. 3.9% expected and 3.1% in September, while CPIH picked up to 3.8% y/y vs. 3.1% expected and 2.9% in September. Headline was the highest since December 2011 and further above the 2% target. Despite this CPI print, WIRP still suggests Bank of England liftoff December 16 remains near 55%, hardly above the 50-50 pricing earlier this week. This just goes to show how little the market trusts the BOE now after last month’s fiasco. That said, February 3 liftoff remains fully priced in. Mann speaks today.
Brexit tensions continue to simmer. Talks continue this Friday in Brussels. U.K. officials continue to threaten unilateral action on the Northern Ireland Protocols, but Brexit Minister Frost warned the EU not to start a trade war if that were to happen. He said “I hope everyone can step back from that. I don’t see why it would help for the response to that from the EU to be sanctions, retaliation, and making trade more difficult.” Mr. Frost is missing the point here. The threat of sanctions and retaliation are what make trade agreements work. If there were no threat of retaliation, then any party would feel free to violate the terms without consequence. As usual, the U.K. is trying to have its cake and eat it too.
The Turkish lira continues to weaken as President Erdogan pushes for lower interest rates. In a speech today, he said “I will continue fighting against interest as long as I continue serving.” While this is nothing new, the timing couldn’t be any worse, ahead of a policy meeting even as USD/TRY was already at record highs. Will the Turkish central bank cut rates at tomorrow’s meeting if the currency is still falling out of bed? Orthodoxy says no but Turkey’s monetary policy is anything but orthodox. Bloomberg median consensus sees a 100 bp cut to 15%, but expectations are all over the place. Of the 24 analysts polled by Bloomberg, 1 sees a 150 bp cut, 18 see 100 bp, 3 see 50 bp, and 2 see no cut. It's delivered two dovish surprises in a row and while we thought it would be hard-pressed to do so again now, Erdogan’s comments argue for a potential third one.
Japan reported soft October trade and September core machine orders data. Exports rose 9.4% y/y vs. 10.3% expected and 13.0% in September, while imports rose 26.7% y/y vs. 31.8% expected and 38.2% in September. Auto exports continued to slump from supply chain issues, falling by more than a third. Exports to the U.S> rose a meager 0.4% y/y, while those to China rose Orders were expected to rise 1.7% m/m but instead came in flat vs. -2.4% in August, pushing the y/y rate down to 12.5% from 17.0% in August. The data suggest that after contracting in Q3, the economy continues to lost some momentum as we move into Q4. That is what makes the upcoming fiscal package all the mor important.
Crypto assets continue to correct with Bitcoin dipping back below the $60K level. There are a few drivers in play here including the stronger dollar, subsiding excitement about the Bitcoin futures ETF, and the usual leverage trading liquidations. However, the latest leg of this this sell-off seems to be driven largely by regulatory concerns, especially surrounding Decentralized Finance (DeFi), and the risk of imminent action by the SEC in this space. Another related thread is the risk that U.S. institutions might face regulatory pushback from holding Ethereum-based products such as Grayscale’s Ethereum Trust (ETHE) due to its role in DeFi.