• U.S. yields continue to fall; Fed officials have remained hawkish all week long; August core PCE will be important; September Chicago PMI will also be key; weekly jobless claims point to a solid NFP; Colombia delivered a dovish surprise and hiked rates 100 bp to 10.0% vs. 150 bp expected
  
• September eurozone CPI readings came in hot; the Tories are paying a price for the recent turmoil; yet U.K. assets have rallied this week on the hopes that the tax plan will be reversed; Deputy Governor Ramsden said that the gilts bought by the BOE to stabilize markets will be sold off as soon as possible; BOE tightening expectations have eased as hopes for a U-turn picked up
  
• Japan reported firm August labor market data, IP, and retail sales; Prime Minister Kishida has reportedly instructed his cabinet to come up with another economic package by the end of October; BOJ announced it will buy more bonds with maturities of five years or more in Q4; China reported soft official September PMI readings; policymakers are taking more action to support the property sector

The dollar is rebounding as the week, month, and quarter draw to a close. We believe that some rebalancing flows may have been behind some of these counter-trend FX moves that we saw this week. Once these flows subside, we believe the upward dollar trend will resume in force. DXY is up modestly today and trading near 112.299 after two straight down days. We expect an eventual test of this week’s new cycle high near 114.778. Sterling traded as high as $1.1235 today but we see limited upside as the Truss government shows no signs of reversing its disastrous fiscal plan. Once markets realize this, we look for an eventual test of this week’s new all-time low near $1.0350. The euro rally ran out of steam today near $0.9855 despite higher than expected eurozone CPI data that supports aggressive ECB tightening. The fundamentals remain poor and so we look for an eventual test of this week’s new cycle low near $0.9535. USD/JPY continues to trade just below 145 but we believe markets are likely to soon test the BOJ’s resolve. The combination of ongoing risk off impulses and repricing of Fed tightening risks is likely to keep the dollar bid across the board near-term. With the outlook for the rest of the world still worsening, the global backdrop continues to favor the dollar and U.S. assets in general.

AMERICAS

U.S. yields continue to fall. After peaking near 4.02% Wednesday, the 10-year yield is currently around 3.67%. Likewise, after peaking near 4.35% Monday, the 2-year yield is currently around 4.14%. We believe there is a lot of noise in the U.S. bond market right now that’s being driven by developments in the U.K. as well as month- and quarter-end flows. Looking through the noise, we believe U.S. yields will resume their upward march and lend support to the dollar.

Fed officials have remained hawkish all week long. Brainard, Bowman, Barkin, and Williams wrap things up today. Yesterday, Mester said her rate forecast is probably above the Fed’s median and noted that rates are still not in restrictive territory. Responding to whether a recession would stop her from hiking rates, she said “We’ve got to get to price stability. So we’re going to do what we have to do to get the price stability. So, no.” Elsewhere, Bullard said “If you look at the dots, it does look like the committee is expecting a fair amount of additional moves this year. I think that that was digested by markets and does seem to be the right interpretation.” WIRP suggests another 75 bp hike is almost fully priced in for November 2, as is a follow-up 50 bp hike December 14. Elsewhere, the swaps market is pricing in a terminal rate of 4.5%, down from the 4.75% peak last week.

August core PCE will be important. Consensus sees it picking up a tick to 4.7% y/y and comes after it fell two ticks in July. This is why the Fed continues to stress that it will not focus on only one or two inflation readings. Rather, the Fed clearly wants to see a sustained drop in the inflation measures before it will even contemplate a pivot. Personal income and spending will be reported at the same time and are expected at 0.3% m/m and 0.2% m/m, both a ticker higher than July.

September Chicago PMI will also be key. It is expected at 51.8 vs. 52.2 in August. Last week, preliminary September S&P Global PMIs came in higher than expected and moved closer to the ISM readings, which have been more upbeat. September ISM readings will be reported next week. Final September University of Michigan consumer sentiment will also be reported today.

Weekly jobless claims point to a solid NFP. Initial claims came in at 193k vs. 215k expected and a revised 209k (was 213k) last week, which were for the BLS survey week containing the 12th of the month. This week improved on that and fell to the lowest since late April while the four-week moving average of 207k was the lowest since late May. Continuing claims are reported with a one-week lag and so this week’s reading will be for the BLS survey week. These claims fell to 1.347 mln vs. 1.385 mln expected and a revised 1.376 mln (was vs. 1.379 mln) last week, the lowest since early July. The recent claims data point to continued resilience in the labor market. Current consensus for September NFP next Friday is 250k vs. 315k in August but there are still many more clues to come.

Colombia central bank delivered a dovish surprise and hiked rates 100 bp to 10.0% vs. 150 bp expected. The vote was 6-1 with the dissent in favor of a smaller 50 bp move. The bank raised its 2022 growth forecast to 7.8% vs. 6.9% previously but cut its 2023 forecast to 0.7% vs. 1.1% previously. It noted that “Over the next months, there are signs of deceleration in productive activity. The fears of a global recession have increased, causing reductions in commodities prices.” This is a very different tone than the last policy meeting July 29, when the bank hiked 150 bp and Governor Villar said then that “The excess of demand continues, with economic activity that remains strong. World inflation has continued to increase, and acquired a greater persistence.” Despite the dovish hold, the swaps market is pricing in 300 bp of tightening over the next 6 months that would see the policy rate peak near 13.0%, up from 12.0% at the start of this week.

EUROPE/MIDDLE EAST/AFRICA

September eurozone CPI readings came in hot. For the eurozone as a whole, headline inflation came in at 10.0% y/y vs. 9.7% expected and 9.1% in August while core came in at 4.8% y/y vs. 4.7% expected and 4.3% in August. Both are new record highs. France and Italy also reported inflation data today. EU Harmonized CPI for France came in at 6.2% y/y vs. 6.6% expected and actual in August and for Italy came in as expected at 9.5% y/y vs. 9.1% in August.

This should keep ECB tightening expectations heightened. WIRP suggests another 75 bp is almost full priced in for the next meeting October 27, while the swaps market is pricing in 225 bp of tightening over the next 12 months that would see the deposit rate peak near 3.0%, up from 2.75% at the start of last week.

The Tories are paying a price for the recent turmoil. According to the latest YouGov survey, opposition Labour now has 54% support vs. 21% for the ruling Tories. YouGov described this 33-point lead as the biggest enjoyed by any party with any polling company since at least the late 1990s. Of note, the Lib Dems have 7% support, followed by the Greens with 6%, the SNP with 5%, and Reform U.K. with 4%. The next general election must be called by January 2025. It's hard to imagine how the Tories can dig themselves out of this hole, especially as the economy is going to do much worse over the next 12-18 months. Speculation is already rising that the Tories will replace Truss if the situation continues to deteriorate but we don’t think we are anywhere near that tipping point yet.

Indeed, U.K. assets have rallied this week on the hopes that the tax plan will be reversed. Long-end gilt yields have tumbled while sterling has rallied. This is truly paradoxical, as the improvement in sentiment will most likely give Truss and Kwarteng more confidence to push the controversial plan through. Maximum pressure from the so-called bond market vigilantes is a necessary but not sufficient condition to force some sort of policy U-turn. As things stand, Truss shows no sign of backing down.

Bank of England Deputy Governor Ramsden said that the gilts bought by the bank to stabilize markets will be sold off as soon as possible. Specifically, when “risks to market functioning are judged to have subsided.” He stressed that the gilt purchases are “strictly time limited” and “temporary,” an indication the BOE hopes to unwind the position relatively quickly. Like the Fed did back in 2019 when it restarted bond purchases to quell funding market dislocations, the BOE also wants to distinguish these emergency bond purchases from Quantitative Easing. Indeed, it appears that any gilts bought during this emergency operation September 28-October 14 will be held in a separate portfolio from its past QE purchases.

Bank of England tightening expectations have eased as hopes for a U-turn picked up. WIRP is now pricing in a 125 bp hike November 3 vs. 150 bp earlier this week, while the swaps market is pricing in a peak policy rate near 5.5% over the next 6 months, down from 6.0% at the start of this week. Here, the thinking goes that if the tax plan is reversed or modified, the BOE will have less tightening to do in order to offset the inflationary impulses. Again, this seems to be wishful thinking at this point as there have been absolutely no signs that Truss will backtrack.

ASIA

Japan reported firm August labor market data, IP, and retail sales. Unemployment fell a tick as expected to 2.5% even as the job-to-applicant ratio rose three ticks to 1.32. IP came in at 2.7% m/m vs. 0.2% expected and 0.8% in July while sales came in at 1.4% m/m vs. 0.2% expected and a revised 0.8% (was 0.7%) in July. However, the economy faces many headwinds and so policymakers will remain cautious and maintain stimulus.

Prime Minister Kishida has reportedly instructed his cabinet to come up with another economic package by the end of October. Chief spokesperson Matsuno said the measures are meant to help the economy cope with higher inflation by addressing rising prices and encouraging pay increases. No further details were released, including the potential size of the package. Kishida has already extended existing relief measures including gas subsidies and caps on imported wheat prices earlier this month as well as boosting cash handouts for low-income households. Matsuno said an additional budget to fund the spending will be passed.

Elsewhere, the Bank of Japan announced it will buy more bonds with maturities of five years or more in Q4. The increase is not surprising as upward pressure on long-term yields this month forced the bank to hold several unscheduled bond-buying operations and boost purchases at its regular operations. As the BOJ just delivered another dovish hold last week, we expect the market to continue testing it in Q4 in terms of yields and the yen. And therein lies the BOJ’s quandary: it cannot maintain low yields and also avoid a weak yen, as the two go hand in hand. While the bank has unlimited firepower to buy JGBs, its capacity to defend the yen is limited. Reports suggest it will soon announce how much it spent last week to support the yen.

China reported soft official September PMI readings. Manufacturing came in at 50.1 vs. 49.7 expected and 49.4 in August but non-manufacturing came in at 50.6 vs. 52.4 expected and 52.6 in August. As a result, the composite fell to 50.9 vs. 51.7 in August. Caixin also reported its manufacturing PMI at 48.1 vs. 49.5 expected and actual in August. Its service and composite PMI readings will be reported next Saturday local time. With the economic outlook still weak, the PBOC is likely to continue easing. Interest rate differentials have moved dramatically in the dollar’s favor.

Policymakers are taking more action to support the property sector. The People’s Bank of China and the China Banking and Insurance Regulatory Commission recently told the biggest state-owned banks to extend at least CNY600 bln ($85 bln) of net financing to the property sector in the final four months of this year. The six largest banks were told to each offer at least CNY100 bln of financing in any form, including mortgages, loans to developers, and purchases of developer bonds. This comes after the central government offered a tax incentive for residential purchases. Reports suggest buyers of new homes within one year after selling their old homes will enjoy refunds for personal income taxes. These tax refunds will take effect from October through the end of 2023.