• The two-day FOMC meeting begins today and is expected to end tomorrow with a tapering announcement; the market has taken that process a step further and is pricing in around 50% odds for liftoff in Q2; U.S. data remain strong; fiscal stimulus hit another roadblock
  
• Eurozone reported softer final October manufacturing PMI readings; markets are still digesting last week’s ECB meeting; Switzerland reported October CPI
  
• RBA abandoned Yield Curve Control, as expected, but maintained its dovish tone; Australian yields and AUD are down on the day; sentiment across Asia was soured by negative Covid headlines from China; Korea’s headline inflation spiked to 3.2% y/y
  

The dollar is firm as the two-day FOMC meeting begins. DXY is trading just below 94.0 as it moved back yesterday into the 93.50-94.00 trading range that has largely held since mid-October. The euro is trading heavy near $1.16 as the post-ECB euphoria wears off, while sterling is trading at the weakest level since October 13 near $1.3630 ahead of the BOE meeting Thursday. USD/JPY is trading heavy near 113.50 as it joins EUR/CHF in signaling some risk-off impulses are picking up. AUD is the worst performing major after the RBA abandoned YCC but kept its dovish tone (see below). We expect U.S. yields and the dollar to continue rising. This week’s FOMC meeting and jobs report could prove to be the catalyst as both are expected to be dollar-supportive.

AMERICAS

The two-day FOMC meeting begins today and is expected to end tomorrow with a tapering announcement. At this point, the Fed has managed expectations perfectly in terms of preparing the markets for what is likely to be speed tapering. Most officials seems to agree that it’s better to get tapering over as quickly as possible in order to leave the Fed maximum flexibility to hike rates when needed. We believe that the most likely path for tapering has already been flagged by the Fed, which would reduce asset purchases by $15 bln per month ($10 bln UST and $5 bln MBS). We also believe the Fed will start tapering this month so that QE effectively ends by mid-2022.

The market has taken that process a step further and is pricing in around 50% odds for liftoff in Q2. Q3 liftoff is already fully priced in, followed by another hike fully priced in for Q4. This is much more aggressive than what the Fed itself anticipates, at least in the current Dot Plots. We suspect the Fed will try to push back a bit against such aggressive tightening expectations, but we are not sure that the market will listen. Next updated forecasts and Dot Plots will come at the December 14-15 meeting.

U.S. data remain strong. Yesterday, October ISM manufacturing PMI came in at 60.8 vs. 60.5 expected and 61.1 in September. Readings above 60 are rare and yet here we are above 60 for 8 of the past 11 months. Looking at the components, employment came in at 52.0 vs. 50.2 in September, while prices paid came in at 85.7 vs. 81.2 in September. Employment component of 52.0 is the highest since July, when 57k manufacturing jobs were added out of 1.09 mln total NFP gain. All in all, this was a very solid report. ISM services PMI will be reported Wednesday. That employment component and ADP that same day will be the final clues to Friday jobs. Current consensus is 450k and we suspect it will creep higher. October auto sales (12.5 mln annual rate expected) will be reported today, while Canada reports September building permits (3.0% m/m expected).

Fiscal stimulus hit another roadblock. Senator Manchin yesterday said that Congress needs more time to study the impact of President Biden’s proposed “human infrastructure” bill. In particular, he wants a “complete analysis” to calculate its true cost and the potential impact on inflation and government debt. Manchin also criticized the progressive win g of his party for holding up the vote on the traditional infrastructure bill. Reports suggest House Speaker Pelosi will push ahead with plans for floor votes this week on both bills, while House Rules Committee Chairman McGovern, said his panel would likely meet Wednesday to set the table for floor debate. This is a calculated gamble on the part of Pelosi as her progressive wing has refused to support the traditional infrastructure bill until Senate support for the “human infrastructure” bill has been nailed down. Stay tuned.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported softer final October manufacturing PMI readings. Headline PMI fell two ticks from the preliminary to 58.3, as Germany’s fell four ticks to 57.8 and France’s rose one tick to 53.6. Italy and Spain were reported for the first time at 61.1 and 57.4 vs. 59.7 and 58.1 in September, respectively. Final services and composite PMI readings will be reported Thursday. For the most part, the eurozone data have been coming in soft recently and certainly gives the doves more leverage as the ECB debates the fate of QE.

Indeed, markets are still digesting last week’s ECB meeting. There will be plenty of ECB officials speaking this week to (hopefully) help clarify the situation. Enria and Elderson speak today, followed by Elderson again, Centeno, and Lagarde tomorrow. Of note, the swaps market is pricing 11 bp of tightening over the next twelve months, down from over 20 bp right after Thursday’s decision and pretty much right back where it was trading before the meeting. The euro is also trading back to where it was before the meeting and so we’re back to square one, it seems.

Switzerland reported October CPI. Inflation came in at 1.2% y/y vs. 1.1% expected and 0.9% in September, while EU Harmonized inflation came in at 1.3% y/y vs. 1.1% expected and 0.8% in September. Both readings are the highest since August 2018 and are worth noting as EUR/CHF traded yesterday just below 1.055, the lowest since May 2020. That month’s cycle low near 1.05 is coming into sight and while technical indicators are getting stretched, that doesn’t preclude further CHF gains. We suspect SNB is intervening down here, as the strong franc will feed into disinflationary pressures. Of note, Swiss retail sales were also reported earlier and rose 2.5% m/m vs. a revised 0.8% (was 0.5%) gain in August..

ASIA

Reserve Bank of Australia abandoned Yield Curve Control, as expected, but maintained its dovish tone. The bank noted that “The decision to discontinue the yield target reflects the improvement in the economy and the earlier-than-expected progress towards the inflation target.” Rates were kept steady at 0.10% and QE will be maintained at the current weekly pace of AUD4 bln until the next review in February. However, the bank pushed back against the market’s aggressive tightening expectations by stressing again that it won’t hike rates until inflation is sustainably within the 2-3% target range, adding “This will require the labour market to be tight enough to generate wages growth that is materially higher than it is currently. This is likely to take some time. The Board is prepared to be patient, with the central forecast being for underlying inflation to be no higher than 2.5% at the end of 2023 and for only a gradual increase in wages growth.”

Australian yields and AUD are down on the day. The yield on the targeted April 2024 bond is flat near 0.65%, while the 10-year yield is down 2 bp to trade near 1.88%. AUD is the worst performing major currency on the day, down nearly 1% as the FX market doesn’t like the RBA’s dovish message. Governor Lowe said in his press conference that while it is possible that rates may not increase until 2024, it is now also plausible that it might be appropriate to hike rates in 2023. However, he warned that “There is genuine uncertainty as to the timing of future adjustments in the cash rate.” Of note, the swaps market is pricing 75 bp of tightening over the next twelve months. The bank will release its Statement on Monetary Policy Friday, which will detail the new macro forecasts.

Sentiment across Asia was soured by negative Covid headlines from China. The government warned of a worsening trend, while several provinces tightened mobility rules and Beijing was forced to close 18 schools. While the numbers of cases are still very small in absolute terms, the government will react vigorously to prevent them from rising. This probably means that the usual wedge between services and the industrial sector will remain wide.

Korea’s headline inflation spiked to 3.2% y/y, though slightly below expectations for a 3.3% increase. The move is largely due to base effects but also shows some underlying price pressures, including transport, while food prices have been easing. The bottom line is that even without base effects, the reading would still be higher than the BOK’s 2.0% target. We think the BOK is more likely than not to deliver another 25 bp hike at the next policy meeting November25, consolidating its position as one of the few hawkish central banks in the region, despite having started off from a very low base. BOK hawkishness is largely priced in, however, so it shouldn’t lead to any material impact of local assets.