• U.S. yields are edging higher; future Fed decisions remain data dependent; U.S. midterm elections today could have important implications for 2023
  
• ECB officials remain hawkish; eurozone and Italy reported September retail sales; BOE Chief Economist Pill warned that recent market turmoil led to a de-anchoring of inflation expectations; BOE tightening expectations need to adjust lower
  
• BOJ released the summary of opinions for the October 27-28 meeting; MOF data showed that the BOJ only intervened once in September; Japan also reported September cash earnings and household spending; RBNZ Governor Adrian Orr was appointed to a second 5-year term; RBNZ tightening expectations remain heightened; Taiwan reported October CPI and trade data
  

The dollar is getting some modest traction as U.S. yields edge higher. DXY is up for the first time after two straight down days and is currently trading near 110.40. The euro rally stalled out above $1.00 and further gains will be difficult given the negative fundamental backdrop there. Likewise, the sterling stalled out above $1.15 and is facing a very difficult fundamental backdrop. The yen continues to outperform, with USD/JPY very heavy as it trades near 146.35. We remain puzzled by the lack of follow-through buying for the dollar as last week’s combination of a hawkish Fed and strong U.S. data. The ongoing repricing of the Fed tightening path is likely to see the dollar recover after this recent correction. Much will depend on the Fed and how the U.S. data come in but so far, the signs still remain positive for the greenback.

AMERICAS

U.S. yields are edging higher. The 2-year yield traded at a new cycle high near 4.80% Friday and was the highest since July 2007. It ended last week near 4.66% but has since recovered to trade near 4.74% today. The 10-year yield traded as high as 4.22% last week. It ended near 4.16% but has since recovered to trade near 4.24% today. If the Fed continues to hike aggressively as we expect, U.S. yields should continue climbing. It’s worth noting that the 2-yaer differentials with Japan and the U.K. are making new cycle highs, while the differential with Germany has fallen back a bit after peaking near 264 bp last week.

Future Fed decisions remain data dependent. We will get one more jobs reports and two sets of inflation and retail sales data before the December 13-14 meeting. WIRP suggests a 50 bp hike then is fully priced in, with 30% odds of a larger 75 bp move. The swaps market continues to price in a terminal rate near 5.25%. There are no Fed speakers nor U.S. data today.

The U.S. midterm elections today could have important implications for 2023. That is because Congressional Republicans have threatened a debt ceiling showdown next year in an effort to cut entitlements and Medicare if they win a majority in the House. In recent weeks, polls have been tilting in favor of the Republicans in both the House and the Senate. Some reports suggest that Congressional Democrats will consider acting on the debt ceiling during the lame duck session in early 2023 if they lose control of Congress. Of note, many equity analysts are suggesting that equities will rally on a split government based on historical patterns. However, it’s important to know how many of those rallies came when the Fed was as tightening as aggressively as it is now.

EUROPE/MIDDLE EAST/AFRICA

ECB officials remain hawkish. Nagel said “We must ensure that high inflation ends soon. I will therefore continue to do my utmost to ensure that we, the Governing Council of the ECB, don’t let up too early and that we continue to push ahead with monetary policy normalization -- even if our measures damp economic development.” He added that “in a situation where monetary policy gets behind the curve, the overall economic costs would be significantly higher.” Wunsch also speaks today. ECB tightening expectations remain steady. WIRP suggests another 75 bp is about 60% priced in for December 15 vs. fully priced in after the October decision, while the swaps market is pricing in a peak policy rate between 3.0-3.25% vs. 3.5-3.75% after the October decision.

Eurozone and Italy reported September retail sales. Italy came in at 0.5% m/m vs. 0.2% expected and a revised -0.3% (was -0.4%) in August, while the eurozone came in as expected at 0.4% m/m vs. a revised flat (was -0.3%) in August. The y/y rate came in at -0.6% vs. -1.1% expected and a revised -1.4% (was -2.0%) in August. While the solid data are welcome, Madame Lagarde warned that the economy is expected to deteriorate further in Q4 an Q1.

BOE Chief Economist Pill warned that recent market turmoil led to a de-anchoring of inflation expectations. He added that “What we’re most concerned about is whether this self-sustaining inflation will persist.” This seems a bit of an overstatement; inflation expectations have edged higher since late September but remain below their peaks earlier in the year. Pill noted that the bank will “have more to digest” about how fiscal policy will impact the economy after the budget statement is released November 17. Pill also said that he’s skeptical that front-loading rate hikes has a big impact on lowering inflation expectations and with regards to further tightening added that “We have done some, and I think there is still more to do. At some point you have to think what level of rate is appropriate.” Pill speaks again later today.

BOE tightening expectations need to adjust lower. After its dovish message last week, WIRP suggests only 50% odds of another 75 bp hike December 15. The swaps market is still pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 4.75%. This is down sharply from 6.25% right after the mini-budget in late September, but basically what is was when the BOE met and deemed market expectations too high. it seems that this should move even lower.

ASIA

The Bank of Japan released the summary of opinions for the October 27-28 meeting. The bank delivered another dovish hold and so it’s no surprise that the opinions tilted dovish as well. One voiced concern about the JGB market, noting “As ensuring stability in the bond market is important, it is necessary to continue to gain a detailed grasp of market conditions through monitoring and other means.” Another said that it’s important to examine the impact of inflation on households to pay close attention to side effects of monetary stimulus. One member said that continued monetary easing is necessary for raising productivity and wages. Another said it’s important to continue studying how future exit strategies will impact markets and whether they are prepared for it. Another said exchange rates should reflect economic fundamentals. Lastly, one said that the economy is starting to show signs of a virtuous cycle.

Ministry of Finance data showed that the BOJ only intervened once in September. According to the detailed Q3 data, it spent JPY2.84 bln ($19 bln) to support the yen on September 22. Previous monthly data did not give a daily breakdown of its intervention. Furthermore, the monthly data show the BOJ spent JPY6.3 trln ($42.9 bln) last month but we won’t get the daily breakdown until detailed Q4 data is reported in early February. The report did show a $43.9 bln drop in its holdings of foreign securities, which matches the intervention amounts and suggests the bank funded that intervention via bond sales rather than from its foreign deposits, which were steady at $137 bln last month.

Japan also reported September cash earnings and household spending. Nominal earnings came in at 2.1% y/y vs. 1.7% expected and actual in August, while real earnings came in at -1.3% y/y vs. -1.8% expected and -1.7% in August. While the small pickup in wages is welcome, it’s clear that high inflation is still depressing real wages. We know Bank of Japan officials are reluctant to remove accommodation unless real wage growth picks up and we’re clearly not seeing that yet. Next policy meeting is December 19-20 and another dovish hold is expected. Elsewhere, household spending came in at 2.3% y/y vs. 2.6% expected and 5.1% in August.

RBNZ Governor Adrian Orr was appointed to a second 5-year term. Finance Minister Robertson reappointed Orr after a unanimous recommendation from the bank’s board and noted “Adrian has demonstrated the skills, knowledge and experience to help steer the financial system through the 1-in-100 year economic shock of the pandemic. I have full confidence that he will continue to display the same integrity and leadership in performing his duties as governor in what is still a challenging environment.” His second term will run until 2028. Still, Orr has come under criticism by some for providing too much stimulus during the pandemic. The RBNZ will released a review of its pandemic era policy decisions later this week.

RBNZ tightening expectations remain heightened. WIRP suggests another 75 bp hike to 4.25% November 23 is nearly priced in. The swaps market is pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 5.5%, which is well above the bank’s current expected rate path. We expect a hawkish shift in that rate path when updated macro forecasts are released at the November meeting, though a 5.5% peak seems a bit aggressive if inflation does continue to ease from the 7.3% peak in Q2.

Taiwan reported October CPI and trade data. Exports came in at -0.5% y/y vs. –6.0% expected and 5.3% in September, while imports came in at 8.2% y/y vs. -5.0% expected and -2.4% in September. Export orders continue to weaken, however, suggesting little relief for shipments over the next six months. And it’s not just Taiwan that’s feeling the chill from the mainland slowdown, as other regional exporters are also suffering. Elsewhere, headline CPI came in at 2.72% y/y vs. 2.80% expected and a revised 2.76% (was 2.75%) in September and resumes the decelerating trend from the 3.59% peak in June. While the central bank does not have an explicit inflation target, easing inflation should allow to maintain its modest pace of tightening for now. The swaps market is pricing in a peak policy rate near 2.0%.