- Fed easing expectations continue to shift; Fed Q3 SLOOS will be reported; New York Fed inflation expectations for October will also be reported; NFIB small business optimism firmed; Brazil central bank minutes will be released
- The main German political parties reached an agreement to hold early elections; ECB doves are controlling the narrative; November German ZEW survey was weak; U.K. labor market data were mixed
- Australia confidence measures continue to firm; China assets are showing their disappointment with the lack of aggressive stimulus measures so far
The dollar rally continues. DXY is trading higher for the third straight day to a new cycle high near 105.915 and remains on track to test the June high near 106.130. The euro is leading this move lower in the foreign currencies and is trading at the lowest since April. That month's low near $1.06 is nearing and after that is November 2023 low near $1.0515 and then the October 2023 low near $1.0450. USD/JPY is trading higher near 154.05 and sterling is trading lower near $1.2825. We look for the dollar rally to continue. While the election results have turbo-charged this move, faithful readers will recall that we have been resolute in our belief that the strong U.S. fundamental story continues to favor higher UST yields and a higher dollar. Recent data have showed that the labor market remains firm and supportive of continued robust consumption that is fueling above-trend growth. Despite the 25 bp cut last week, we believe the Fed will continue to take a cautious tone going forward, especially in light of what we view as heightened inflation risks in a second Trump term. Market pricing has already adjusted (see below), which is giving the dollar a huge lift.
AMERICAS
Fed easing expectations continue to shift. The Fed Funds futures market is pricing in only 70% odds of a follow up cut in December and around 50% odds in the swaps market. Those odds will evolve in the coming weeks. Before the next FOMC meeting December 17-18, we get one more jobs report and two more CPI, PPI, and retail sales reports. Of note, the market is now pricing in 75-100 bp of total easing over the next 12 months. To put the market repricing of the Fed into better perspective, the swaps market is now pricing in a terminal rate near 3.5% vs. the low near 2.5% back in September right after the Fed started cutting. Fed officials are likely to reinforce the cautious tone this week. Waller, Barkin (twice), Kashkari, and Harker speak today.
Fed Q3 Senior Loan Officer Opinion Survey will be reported. In Q2, the SLOOS showed the net share of banks reporting tighter lending standards were lower than in Q1 across almost all loan categories. We expect this trend to continue in Q3, as the September FOMC meeting noted that credit remained generally accessible to most corporate and consumer borrowers.
New York Fed inflation expectations for October will also be reported. 1-year expectations are expected to remain steady at 3.0% for the fifth straight month. Just as actual inflation readings have flattened out, so too have inflation expectations.
NFIB small business optimism firmed. Headline came in at 93.7 in October vs. 92.0 expected and 91.5 in September. This was the second straight improvement and matches the cycle high in July. NFIB Chief Economist Dunkelberg noted that "With the election over, small business owners will begin to feel less uncertain about future business conditions. Although optimism is on the rise on Main Street, small business owners are still facing unprecedented economic adversity. Low sales, unfilled jobs openings, and ongoing inflationary pressures continue to challenge our Main Streets, but owners remain hopeful as they head toward the holiday season."
Brazil central bank minutes will be released. Last week, the bank hiked rates 50 bp to 11.25% and made it clear that it was responding to loose fiscal policy as it warned “The Committee stresses that a credible fiscal policy committed to debt sustainability, with the presentation and execution of structural measures for the fiscal budget, will contribute to the anchoring of inflation expectations and to the reduction in the risk premia of financial assets, therefore impacting monetary policy.” The market is pricing in 275 bp of further tightening over the next 12 months that would see the policy rate peak at 14.0%. September retail sales data will also be reported and are expected at 3.7% y/y vs. 5.1% in August.
EUROPE/MIDDLE EAST/AFRICA
The main German political parties reached an agreement to hold early elections. The vote was originally slated for September 28 but has now been moved forward to February 23. Chancellor Scholz will reportedly call for a confidence vote December 16. We think this compromise is preferable to an extended period of uncertainty under Scholz’s original plan to hold elections in March. We an understand why Scholz wanted to delay it as long as possible, as polls suggest his SPD party is running in third place behind the center-right CDU/CSU in first place and the far right AfD in second place. Fiscal policy is on hold until a new government is in place next year. Until then, the ECB will likely have to do the heavy lifting to support the sluggish German growth outlook.
European Central Bank doves are controlling the narrative. Governing Council member Olli said disinflation is “well on track” and the growth outlook “seems to be weakening,” adding “that strengthens the case for a rate cut in December.” Rehn added that the ECB “could be leaving the restrictive territory sometime in the spring, winter of next year, 2025.” Governing Council member Stournaras took a similar tone, noting that “Now inflation is coming down, and because inflation is coming down, we’ve started to lower interest rates, which it looks like we’re going to continue to lower.” Stournaras added that rates could end up “possibly close to 2% around next September.” A December cut is fully priced in, with nearly 25% odds of a larger 50 bp move. Looking ahead, the swaps market is now pricing in 150 bp of ECB easing over the 12 twelve months that would see the policy rate bottom near 1.75%.
November German ZEW survey was weak. Expectations fell to 7.4 vs. 13.2 expected and 13.1 in October, while current assessment fell to -91.4 vs. -85.0 expected and -86.9 in October. ZEW President Wambach noted that “Economic expectations for Germany are influenced by Trump’s victory and the end of the coalition. In the last few days of the survey period, however, more optimistic voices are also becoming increasingly vocal about the economic outlook for Germany due to the likelihood of early elections.”
U.K. labor market data were mixed. The unemployment rate rose to a four-month high of 4.3% for the three months ending in September vs. 4.1% expected and 4.0% in August. The BOE’s Q3 projection was 4.2%. Average private weekly earnings excluding bonuses fell a tick to 4.8% y/y vs. 4.7% expected but in line with the BOE’s Q3 projection. However, total wage growth picked up to 4.3% y/y vs. 3.9% expected. Overall, sticky wage growth reinforces the BOE’s cautious easing guidance. Markets continue to place low odds (about 20%) of 25 bp rate cut in December. The policy rate is seen bottoming at 4.00%, which is in contrast to market expectations that the ECB policy rate will bottom around 1.75%. As a result, the relative monetary policy trend supports a lower EUR/GBP. BOE Chief Economist Pill speaks later today.
ASIA
Australia confidence measures continue to firm. The Westpac Melbourne Institute Consumer Sentiment Index rose to a 30-month high of 94.6 in November vs. 89.8 in October. Elsewhere, the NAB Business confidence index increased 7 points to a 20-month high of 5 and business conditions were unchanged at a five-month high of 7 in October. The market is still pricing in the first 25 bp rate cut in May 2025.
China assets are showing their disappointment with the lack of aggressive stimulus measures so far. USD/CNH surged to 7.2500, the highest since August 2, while China’s benchmark CSI 300 Index is down over 3%. China’s National Development and Reform Commission highlighted that “in the coming period, the domestic market in China will more clearly dominate the economy cycle.” It’s difficult to get excited with this encouraging statement because rebalancing China’s economy toward private consumption has been a key priority since 2004. Yet, China's household consumption remains very low at 39% of GDP while investment accounts for over 40% of GDP. For comparison, the average share of household consumption to GDP ratio in OECD countries is 54%. The most straightforward way to boost private consumption in China is to reduce persistently high household savings rate, which is over 30%. This requires fiscal expansion to increase and unify social safety nets (medical, unemployment, education) and a more progressive tax system.
