• U.S. yields continue to recover; September jobs data is of course the data highlight; the disciplined Fed messaging shows no signs of letting up; Canada highlight is also jobs data; Lula declined to name any of his potential cabinet picks; Mexico reports September CPI
  
• Germany reported some more weak data for August; Fitch cut its outlook on the U.K. to negative from stable; U.K. yields have crept higher
  
• Japan reported August cash earnings and household spending; the RBA warned that financial stability risks have increased in recent months; the debate about financial stability risks has heated up recently; Caixin reports September services and composite PMI readings Saturday local time; Taiwan exports unexpectedly contracted
  

The dollar is holding steady ahead of the jobs report. DXY is trading near 112.100 after two straight up days. Sterling remains heavy after being unable to breach strong resistance near $1.15 and is currently trading just below $1.12. Similarly, the euro remains heavy after being unable to breach strong resistance near $1.00 and is currently trading just below $0.98. USD/JPY continues to flirt with the 145 area but has yet to take another stab at Monday’s high near 145.30 due to ongoing fears of BOJ intervention. This move higher in USD/JPY should continue as markets eventually test the BOJ’s resolve. The combination of ongoing risk off impulses and eventual repricing of Fed tightening risks is likely to see the dollar continue to recover after this recent correction. Much will depend on how the U.S. data come in but so far, the signs are good.

AMERICAS

U.S. yields continue to recover. The 2-year yield is currently back near 4.27% after trading as low as 3.99% Tuesday. The break above 4.21% sets up a test of the September 26 cycle high near 4.35%. Similarly, the 10-year yield is currently back near 3.84% after trading as low as 3.56% Tuesday. A break above 3.84% would set up a test of the September 28 cycle high near 4.02%. Of note, the real 10-year yield has recovered to 1.63% and is nearing the September 30 cycle high near 1.67%. We believe this generalized rise in U.S. yields will continue and lend further support to the dollar.

September jobs data is of course the data highlight. Consensus sees 255k vs. 315k in August, with the unemployment rate seen steady at 3.7% and average hourly earnings seen falling two ticks to 5.0% y/y. Most of the clues point to a solid NFP reading but it will likely be sequentially lower. Earnings will be key for the Fed as it looks for signs that the labor market is getting less tight. Overall, however, the economy remain resilient and today’s data are unlikely to impact the Fed’s near-term path. How resilient? The Atlanta Fed’s GDPNow model is currently tracking Q3 growth at 2.7% SAAR. This is the highest it’s been and was tracking as low as 0.2% SAAR on September 21. Clearly, the recent streak of strong data has improved the overall outlook for Q3. The next model update comes today. Of note, the advance read for Q3 GDP comes October 27 and current Bloomberg consensus stands near 1.5% SAAR. Wholesale trade sales and inventories and consumer credit will also be reported today.

This was another heavy week of Fed speakers. Williams, Kashkari, and Bostic wrap things up today. Yesterday, Kashkari said “We have more work to do. Until I see some evidence that underlying inflation has solidly peaked and is hopefully headed back down, I’m not ready to declare a pause. I think we’re quite a ways away from a pause.” Evans said he is expecting further rate hikes and is looking for 125 bp of tightening over the next two meetings. He said that the momentum in core inflation is most concerning to the Fed and acknowledged that it should have hiked sooner. Cook said restoring price stability will require ongoing rate hikes and that the Fed is likely to keep policy restrictive “for some time.” She said the Fed is willing to alter its course as the data evolve and that officials will learn the appropriate peak policy rate over time. Waller said it’s hard to pause rate hikes until inflation moderates. He added that he doesn’t see financial stability concerns slowing the Fed’s rate hikes, adding that it’s not the Fed’s job to solve other country’s problems. Waller said he sees additional rate hikes into early next year and that the Fed is watching the data to decide the appropriate pace of tightening. Lastly, Mester said she has seen no evidence to warrant slowing the pace of rate hikes. She added that she does not envision the Fed cutting rate next year.

The disciplined Fed messaging shows no signs of letting up. This communication effort that began at Jackson Hole has remained clear and consistent, with no official muddying the message with a different take. Yet markets continue to hold out hope for the start of an easing cycle next year. This is clearly not happening. When will markets get the message? That said, WIRP suggests over 90% odds of a 75 bp hike November 2, which we think is a done deal after the recent data. Looking ahead, the swaps market is pricing in a peak policy rate between 4.50-4.75%.

Canada highlight is also jobs data. Consensus sees 20.0k jobs added vs. -39.7k in August, while the unemployment rate is expected to remain steady at 5.4%. Yesterday, Bank of Canada Governor Macklem said there is “more to done” in terms of curbing inflation and added that the bank is not yet ready for a “more finely balanced” policy stance. Specifically, he said more data is required before the bank pivots to a “decision-by-decision approach.” BOC tightening expectations had fallen after a batch of weak data, including August jobs, but have risen after Macklem’s hawkish comments. WIRP suggests a 50 bp hike October 26 is now fully priced in vs. less than 65% odds earlier this week. Indeed, WIRP suggests nearly 35% odds of a larger 75 bp move. Looking ahead, the swaps market is pricing in a terminal rate near 4.25% over the next 6 months vs. 4.0% at the start of this week.

Former President Lula and current frontrunner in the October 30 runoff declined to name any of his potential cabinet picks. Specifically, he said it would be “crazy” to name his cabinet members until he has beaten current President Bolsonaro in the runoff. We disagree. Many candidates around the world , both EM and DM, have identified cabinet picks ahead of an election in order to put markets (and voters) at ease. While it is not required, it often makes sense to do so. At the same time, Lula also reiterated his opposition to a spending cap whilst promising to remain responsible. On another note, polls are tightening up. The latest one shows Lula ahead 48-44% (52-48% when considering only valid votes), which is much narrower than previous polls that showed Lula with double digit leads in the runoff.

Mexico reports September CPI. Headline is expected at 8.75% y/y vs. 8.70% in August, while core is expected at 8.34% y/y vs. 8.05% in August. If so, it would be the first deceleration since May but inflation would remain well above the 2-4% target range. Banco de Mexico last week hiked rates 75 bp to 9.25% and said “The Board will assess the magnitude of the upward adjustments in the reference rate for its next policy decisions based on the prevailing conditions.” Governor Rodriguez stressed that “As we said in our statement, the governing board considered that this cycle of increases has not ended” but added that it’s hard to anticipate how high rates will need to go. Next policy meeting is November 10 and while another hike is expected, the size will depend on whether inflation slows further in October. The swaps market is pricing in 150 bp of tightening over the next 6 months that would see the policy rate peak near 10.75%.

EUROPE/MIDDLE EAST/AFRICA

Germany reported some more weak data for August. Retail sales and IP were reported. Sales came in at -1.3% m/m vs. -1.2% expected and a revised 0.7% (was 1.9%) in July. As a result, the y/y rate fell to -4.3% vs. -2.3% in July. Elsewhere, IP came in at -0.8% m/m vs. -0.5% expected and a revised flat reading (was -0.3%) in July. However, the y/y rate improved to 2.1% from a revised -0.8% in July. Overall, Germany is proving to be the weak link in the eurozone and is likely to drag the rest of the region into recession with it. Still, a 75 bp hike by the ECB October 27 is nearly priced in while the swaps market is pricing in 225-250 bp of tightening over the next 12 months that would see the deposit rate peak between 3.0-3.25%.

Fitch cut its outlook on the U.K. to negative from stable. The agency said “The large fiscal stimulus, announced without compensatory measures or an independent evaluation of the macroeconomic and public finances’ impact, and the inconsistency between fiscal and monetary policy stance given strong inflationary pressures, have in Fitch’s view, negatively impacted financial markets’ confidence and the credibility of the policy framework.” This comes almost a week after S&P did the same to its U.K. rating. Moody’s has also warned that the government’s fiscal plan risks lasting damage to the U.K. debt dynamics. Of note, S&P rates the U.K. the highest at AA while Fitch is at AA- and Moody's is at Aa3 (equivalent to AA-). If Truss and Kwarteng stick with the rest of their fiscal plan, we expect actual downgrades will be seen next year.

U.K. yields have crept higher. Part of this is rising U.K. credit risk, but part of this is also reflect concerns that the gilt market may seize up again when the BOE ends its emergency purchase program next Friday. Market expectations for BOE tightening have eased in recent days. WIRP suggests a 125 bp hike is nearly priced in vs. 150 bp last week, while the swaps market is pricing in a peak policy rate near 5.75% vs. the cycle high near 6.25% last week.

ASIA

Japan reported August cash earnings and household spending. Nominal cash earnings came in at 1.7% y/y vs. 1.4% expected and 1.3% in July, while real cash earnings came in -1.7% y/y vs. -1.8% expected. Real earnings have contracted y/y for five straight months and remain near the lows of this cycle. Elsewhere, spending came in at 5.1% y/y vs. 6.7% expected and 3.4% in July. The data encapsulate the dilemma that the Bank of Japan faces. Higher inflation may warrant a monetary policy response, but that has been offset by falling real wages that are leading to slower consumption. We know from various BOJ comments that the bank really wants to see a sustained rise in wages before it will contemplate an exit from stimulus, so the earnings data has taken on just as much importance as the CPI data. For now, however, the BOJ is clearly on hold. Next policy meeting is October 27-28 and no change is expected then.

The Reserve Bank of Australia warned that financial stability risks have increased in recent months. In its semiannual Financial Stability Review, the bank noted that some households and businesses are already facing “more challenging conditions” as interest rates and inflation rise. Specifically, the bank warned “Household income growth has not kept pace with inflation. This has left households with less capacity to meet their rising housing costs -- loan payments or rent -- while maintaining their consumption and rate of saving.” The RBA noted that its modeling shows the share of households at high risk of default is likely to remain low over the coming years based on its central scenario for employment and growth. However, if economic conditions deteriorated further than assumed in the central scenario, “a large share of households would be expected to fall into arrears on their mortgages.” Lastly, the RBA noted that Australia’s financial system remains resilient, its banks are well-capitalized, and loan arrears are low.

The debate about financial stability risks has heated up recently. This is due in part to a research piece by the New York Fed called “The Financial (In)Stability Real Interest Rate, R**” that was first published in November 2020 and revised this month. It’s worth a read but the authors raise the possibility that the Fed may reach an interest rate r** where financial stability concerns kick in before it is able to reach the rate r* that is consistent with full employment and stable inflation. This month’s revision brought renewed attention to this debate; when this piece was written two years ago, inflation was low, nominal interest rates were zero, and no one imagined that central banks around the world would be tightening at such a breakneck pace.

Caixin reports September services and composite PMI readings Saturday local time. Services PMI is expected at 54.4 vs. 55.0 in August. Last week, official PMI readings came in soft. Non-manufacturing PMI came in at 50.6 vs. 52.6 in August and dragged the composite PMI down to 50.9 vs. 51.7 in August. We expect stimulus to continue in the coming months. China reopens Monday from its Golden Week holiday.

Taiwan exports unexpectedly contracted. September exports came in at -5.3% y/y vs. 2.4% expected and 2.0% in August. This was the first contraction since June 2020 and the worst since January 2020. Export orders have also been sliding, which points to continued weakness over the next six months. It’s not just Taiwan, as a regional slowdown driven by weakness in mainland China has also weighed on Korean exports. Unfortunately, this is likely to get worse before it gets better.