• Treasury Secretary Yellen gave a green light to a stronger dollar; we are seeing continued hawkishness from the Fed; September PPI will be the highlight; FOMC minutes will be of interest; Chile is expected to hike rates 50 bp to 11.25%
  
• BOE Governor Bailey affirmed that its emergency bond-buying will end Friday; U.K. Prime Minister Truss will meet with Tory MPs today; the U.K. data dump came in very weak; eurozone reported firm August IP.
  
• Japan reported soft orders data; China reported firm September new loan and money data; Korea hiked rates 50 bp to 3.0%, as expected
  

The dollar continues to rise with Yellen’s blessing. Yellen made it clear that U.S. policymakers are not concerned with the strong dollar right now (see below). DXY is up for the sixth straight day and traded at a new high for this move near 113.592 before easing back to around 113.237 currently. It is on track to test the September 28 high near 114.778. Sterling remains heavy and traded as low as $1.0925 today before bouncing modestly to $1.1030 currently. A break below $1.0905 would set up a test of the September 28 low near $1.0540. The euro also remains heavy and traded as low as $0.9670 yesterday before bouncing modestly to trade near $0.97 currently. It remains on track to test the September 28 cycle low near $0.9535. USD/JPY traded at a new cycle high near 146.45 despite ongoing fears of BOJ intervention. This move higher in USD/JPY should continue as markets test the BOJ’s resolve as the 1998 high near 147.65 comes into view. 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

Treasury Secretary Yellen gave a green light to a stronger dollar. Specifically, she said that “A market determined value of the dollar is in America’s interest. The currency movements are a logical outcome of different policy stances.” Since Treasury runs U.S. FX policy, her statement suggests little concern about the surging greenback at this point. As we all know, a stronger currency is part of the adjustment process when a central bank tightens and the dollar is no different. However, because it is the world’s reserve currency, this strength can have huge knock-on effects around the globe. There have been stresses in several Frontier countries as well as some of the weaker Emerging Market countries, but this is simply beyond the purview of U.S. policymakers. Bottom line: we are nowhere near any type of Plaza-style Accord to arrest the dollar’s ascent.

We are seeing continued hawkishness from the Fed. Yesterday, Mester said “Given the current level of inflation, its broad-based nature, and its persistence, I believe monetary policy will need to become more restrictive in order to put inflation on a sustainable downward path to 2%.” She added that “My read right now is that we still have very high inflation. We have not seen any progress really on inflation and so I think we need to bring interest rates up and I think we need to bring them up through this year and a little bit into next year.” The Fed is clearly hiking by 75 bp November 2. What happens December 14 will be data-dependent. Between the November 2 and December 14 decisions, the Fed will get two full sets of jobs, CPI, PPI, and retail sales data. A lot can happen to the data in that span and we think that is why markets are still pricing in only 50 bp in December. If (and this is a very big if) the data remain firm, the odds of a 75 bp would then rise significantly from around 20% currently.

September PPI will be the highlight. Headline is expected at 8.4% y/y vs. 8.7% in August, while core is expected to remain steady at 7.3% y/y. CPI will be reported tomorrow. Headline is expected at 8.1% y/y vs. 8.3% in August, while core is expected at 6.5% y/y vs. 6.3% in August. Recent Fed official commentary has focused on the trajectory of core inflation, which we presume means both core CPI and core PCE. Both have been accelerating and if that trend continues, the Fed is likely to remain hawkish regardless of the energy-related fall in the headline readings.

FOMC minutes will be of interest. At the September 20-21 meeting, the Fed hiked rates 75 bp and delivered a very hawkish message. Chair Powell drove home this hawkish message in his press conference when he stressed that the Fed is looking for “compelling” evidence that inflation is easing and warned that history cautions against premature rate cuts. Powell noted that despite the slowdown in growth, the labor market remains “extremely tight” and out of balance. Lastly, Powell promised that the Fed will keep at it until it feels the job is done, and warned that this may lead to sustained below-trend growth and very likely softening in the labor market. Powell said there is a possibility of a pause but not at current levels, noting that “We’re at the very lowest level of what is restrictive.” The updated Dot Plots saw the median Fed Funds rate move up to 4.4% in 2022 and 4.6% in 2023. Looking further ahead, the Dots show 3.9% in 2024 and 2.9% in 2025, suggesting no significant easing until well into 2024. Kashkari, Barr, and Bowman speak today.

Chile central bank is expected to hike rates 50 bp to 11.25%. At the last meeting September 6, the bank delivered a hawkish surprise with a 100 bp hike to 10.75% vs. 75 bp expected. There was one dissent in favor of an even larger 125 bp move. The bank noted that “The next move in rates will depend on the macroeconomic scenario. The board will pay special attention to the risk of higher inflation.” Since then, September CPI came in at 14.1% y/y, the highest since September 1992 and further above the 2-4% target range. The swaps market is pricing in 75 bp of tightening over the next 3 months that would see the policy rate peak near 11.5%.

EUROPE/MIDDLE EAST/AFRICA

Bank of England Governor Bailey affirmed that its emergency bond-buying will end Friday. He was quite unequivocal, warning "We will be out by the end of this week. We think the rebalancing must be done. My message to the funds involved, and all the firms involved in managing those funds, is you've got three days left now. You've got to get this done." Quite frankly, it’s a very risky bet. Can the gilt market function normally without its support? The new liquidity measures that have been introduced may help the gilt market function better at the margin but there will no longer be a buyer of last resort. As we’ve said many times, the BOE can address the symptoms but withdrawing support before the underlying malady (irresponsible fiscal policy) has been addressed risks more disorderly moves ahead. If the BOE has to reverse course and start buying gilts again, its policy credibility would be utterly lost. Of note, market expectations for BOE tightening have eased in recent days. WIRP suggests a 125 bp hike is less than 50% priced in vs. 150 bp fully priced in late September, while the swaps market is pricing in a peak policy rate near 5.75% vs. the cycle high near 6.25% in late September.

U.K. Prime Minister Truss will meet with Tory MPs today. Chancellor Kwarteng was originally scheduled to hold a regular meeting with the so-called 1922 Committee but Truss is clearly working on damage control with her own party as Parliament reconvenes from recess. Her meeting comes amidst reports that more Tory MPs are submitting letters of no confidence and rising speculation that junior ministers will resign within weeks. Senior ministers made the weekend media rounds, appearing on TV and writing op-eds calling for Tory unity. Only time will tell if this works, and much will depend on public opinion.

The U.K. data dump came in very weak. August GDP, construction output, IP, services, and trade were all reported. GDP came in at -0.3% m/m vs. flat expected and a revised 0.1% (was 0.2% in July), construction came in at 0.4% m/m vs. 0.5% expected and a revised 0.1% (was -0.8%) in July, IP came in at -1.8% m/m vs. -0.1% expected and a revised -1.1% (was -0.3%) in July, and services index came in at -0.1% m/m vs. flat expected and a revised 0.3% (was 0.4%) in July. Lastly, the trade deficit came in at -GBP7.1 bln vs. -GBP9.0 bln expected and a revised -GBP5.4 bln (was -GBP7.8 bln) in July. Markets are fully expecting a recession in the U.K. by Q4 but it appears that the economy was already losing momentum in Q3. While the BOE sees the recession lasting five quarters, recent developments suggest it could be longer and deeper due to the bank’s need to offset fiscal stimulus with even tighter monetary policy.

Eurozone reported firm August IP. IP rose 1.5% m/m vs. 0.7% expected and -2.3% in July. As a result, the y/y rate improved to 2.5% vs. 1.5% expected and a revised -2.5% (was -2.4%) in July. We view this improvement as temporary even as ECB tightening expectations remain elevated. 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%.

ASIA

Japan reported soft August core machine orders and September machine tool orders. Core machine orders came in at -5.8% m/m vs. -2.% expected and 5.3% in July. However, the y/y rate eased as expected to 9.7% y/y vs. 12.8% in July. Elsewhere, September machine tool orders came in at 4.3% y/y vs. 10.7% in August, the slowest since October 2020. The economy is recovering but headwinds are growing, both domestically and globally. As such, we see no shift in BOJ policy anytime soon and so USD/JPY should continue to rise. Today, the pair traded at new cycle high near 146.40 and should soon test the 1998 high near 147.65. There remains risk of intermittent BOJ intervention but the fundamentals suggest it cannot mount a sustained defense of the yen until the BOJ pivots.

China reported firm September new loan and money data. New loans rose CNY2.47 trln vs. CNY1.8 trln expected and CNY1.25 trln in August, while aggregate financing rose CNY3.53 trln vs. CNY2.75 trln expected and CNY2.43 trln in August. It looks like after very weak July readings, policymakers finally got serious about boosting loans and financing. With the economy facing greater headwinds, we expect stimulus efforts will continue in Q4. That said, the monetary policy divergence with the Fed should continue to weaken the yuan.

Bank of Korea hiked rates 50 bp to 3.0%, as expected. There were two dissents in favor of a smaller 25 bp move. The bank noted that “The Board sees continued rate hikes as warranted, as inflation is expected to remain high, substantially above the target level, although domestic economic activity has slowed.” Governor Rhee added that the bank expects rates to be around 3.5% at the end of this tightening cycle. Regarding the won, Rhee noted “The foreign exchange volatility around the world depends heavily on expectations for a stronger dollar. International financial markets have been shaken by the pace of tightening in the US, but they could also turn around sharply if the US stops raising rates.” Of note, the swaps market is pricing in 75 bp of tightening over the next 12 months that would see the policy rate peak near 3.75%.