• This week starts off quietly before key data for the U.S. start coming out tomorrow; risks of a government shutdown are not insignificant; Moody’s cut the outlook on its Aaa rating for the U.S. to negative from stable
  
• The anticipated U.K. cabinet shuffle brought some unanticipated changes; Bank of England officials are likely to offer dueling headlines; ECB Vice President Guindos warned that inflation may pick up temporarily
  
• Japan reported soft October machine tool orders and PPI; RBA warned of persistent price pressures; China reported October money and new loan data

The dollar is trading sideways ahead of key data later this week. DXY is trading slightly lower for the second straight day near 105.781. Key retracement levels from the November drop come in near 106 and 106.25. The euro is trading flat near $1.0685 while sterling is trading slightly higher near $1.2245 after the shock cabinet shuffle (see below). USD/JPY traded at a new cycle high near 151.85 after soft data but saw no follow though buying after some jawboning from Finance Minister Suzuki. With the dollar rally staling a bit, it will take some firm data to challenge the current dovish Fed narrative. If the data remain firm, the Fed doves (and the market) will 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 will not be able to cut rates as soon as the market thinks.

AMERICAS

This week starts off quietly before key data for the U.S. start coming out tomorrow. Today, only the October budget statement will be reported. The deficit is expected at -$65 bln vs. -$171 bln in September. If so, the 12-month total would fall to -$1.67 trln and would be the lowest since February. Then the deluge starts with CPI tomorrow and PPI, and retail sales data Wednesday. For now, U.S. yields and the dollar are drifting sideways.

Fed tightening expectations remain subdued. WIRP suggests 15% odds of a hike December 13, rising modestly to around 30% January 31. We get plenty of Fed speakers this week but as we have stressed many times before, it will come down to what the data really say. Cook speaks today.

Risks of a government shutdown are not insignificant. Funding for the government runs out at midnight Friday and there has been little tangible progress towards averting a shutdown. Over the weekend, Speaker Johnson unveiled an unusual two-step plan that extends funding for some agencies until January 19 and others until February 2. The plan contained no supplemental funding, including aid for Israel and Ukraine. Johnson hopes to vote on his plan tomorrow. While this plan may appeal to Republican hardliners, it’s hard to see any Democrats supporting it. Time is running out.

Moody’s timing was impeccable as it cut the outlook on its Aaa rating for the U.S. to negative from stable. Late Friday, the agency wrote that “Downside risks to the US’ fiscal strength have increased and may no longer be fully offset by the sovereign’s unique credit strengths. In the context of higher interest rates, without effective fiscal policy measures to reduce government spending or increase revenues, Moody’s expects that the US’ fiscal deficits will remain very large, significantly weakening debt affordability.” More importantly, Moody’s warned that “Continued political polarization within US Congress raises the risk that successive governments will not be able to reach consensus on a fiscal plan to slow the decline in debt affordability.”

EUROPE/MIDDLE EAST/AFRICA

The anticipated U.K. cabinet shuffle brought some unanticipated changes. While Home Secretary Braverman was widely expected to be sacked, the big shock came with former Prime Minister Cameron’s appointment as Foreign Secretary. That post opened up with the appointment of Foreign Secretary James Cleverly to replace Braverman. Because Cameron was not an MP, he was quickly elevated to the House of Lords. We find it rather ironic that the leader responsible for taking the U.K. out of the E.U. is taking up the post of Foreign Secretary. The appointment is very risky as it will remind voter of which party was responsible for Brexit even as the Sunak government gears up for a likely election in 2024.

Bank of England officials are likely to offer dueling headlines. Breeden and Mann speak later today and will likely offer opposing views of the U.K. outlook. At the November 2 decision to hold, leading hawk Mann dissented in favor of a 25 bp hike while newcomer Breeden voted with the 6-3 majority to hold. Of note, the more dovish Breeden replaced Cunliffe, who was one of the 4 hawkish dissents in favor of a 25 bp hike at his last decision September 21. BOE tightening expectations have evaporated. WIRP now suggests 10% odds of a hike December 14, rising modestly to top out near 15% February 1. There are 50% odds of the first cut coming June 20 and is fully priced in for August 1.

ECB Vice President Guindos warned that inflation may pick up temporarily. He noted that “We expect a temporary rebound in inflation in the coming months as the base effects from the sharp increase in energy and food prices in autumn 2022 drop out. But we see the general disinflationary process continuing over the medium term.” Guindos added that “Energy prices remain a major source of uncertainty amid heightened geopolitical tensions and the impact of fiscal measures. The same is true for food prices, which may also come under upward pressure owing to adverse weather events and the unfolding climate crisis more broadly.” ECB tightening expectations remain subdued as WIRP suggests no odds of a hike December 14. After that, only cuts are priced and the first one is nearly 65% priced in for April 11 and fully priced in for June 6.

ASIA

Japan reported weak October machine tool orders. Total orders came in at -20.6% y/y vs. -11.2% in September and was the weakest since June. Foreign orders came in at -18.8% y/y vs. -9.7% in September, while domestic orders came in at -24.5% y/y vs. -14.1% in September. While weakness in foreign orders is to be expected given the challenging global backdrop, policymakers will be concerned with the weakness in domestic orders. September core machine orders will be reported Thursday and are expected at -3.7% y/y vs. -7.7% in August.

Japan also reported soft October PPI. It came in a tick lower than expected at 0.8% y/y vs. a revised 2.2% (was 2.0%) in September. This was the lowest since February 2021 and suggests price pressures are waning. With Q3 GDP expected to show modest contraction later this week, the recent data have pushed Bank of Japan liftoff expectations back from March 19 to April 26. This in turn has helped push USD/JPY to a new cycle high near 151.85 and that in turn has led Finance Minister Suzuki to come out with the usual jawboning.

Reserve Bank of Australia warned of persistent price pressures. Acting Deputy Governor Kohler said inflation is still too high and warned that the next stage is likely to be more drawn out than the first phase. Kohler noted that “This has been the experience of some other advanced economies that have been a little ahead of Australia in this inflation cycle. The recent increase in fuel prices is also a timely reminder that upside surprises from supply shocks could affect headline inflation. All to say, the road ahead could be bumpy.” WIRP suggest no odds of another hike December 5 but rise modestly over the course of next year to top out near 55% in Q2 vs. 35% before last week’s hike.

China reported October money and new loan data. New loans came in at CBY738 bln vs. CNY655 bln expected and CNY2.31 trln in September, while aggregate financing came in at CNY1.85 trln vs. CNY1.95 trln expected and CNY4.12 trln in September. PBOC sets its key 1-year MLF rate Wednesday and is expected to remain steady at 2.5%. With deflation risks rising, we do not think stimulus measures taken so far will have much lasting impact and we so look for more in the coming months.