• Financial conditions continue to loosen; the U.S. economy remains fairly robust; Fed hawks continue to speak up while others are sticking to their dovish stance; Mexico is expected to keep rates steady at 11.25%; Peru is expected to cut rates 25 bp to 7.0%
  
• ECB officials continue to push back against the dovish market narrative; BOE chief economist Pill remains in full dove mode; Poland delivered a hawkish surprise yesterday
  
• BOJ summary of opinions from the October 30-31 meeting saw a clear change in tone from previous meetings; Governor Ueda sounded more dovish; September current account data are worth discussing; China reported soft October CPI and PPI data

The dollar continues to claw back recent losses. DXY is trading higher for the fourth straight day near 105.723 and has retraced over a third of this month’s drop. Key retracement levels come in near 106 and 106.25. The euro is trading lower near $1.0685 while sterling is trading lower near $1.2260 on dovish BOE comments (see below). USD/JPY is trading higher near 151.15 and is on track to test the October 31 high near 151.70. With the dollar clawing back recent losses, it seems the markets finally realized they were getting carried away with the dovish Fed narrative. The U.S. economy continues to grow above trend even as the rest of the world slips into recession, while price pressures remain persistent enough that the Fed will not be able to cut rates as soon as the market thinks. The Fed hawks continue to push back against the dovish narrative (see below) and eventually, the Fed doves (and the market) will have to capitulate.

AMERICAS

Financial conditions continue to loosen. The Chicago Fed’s measure had been tightening very modestly since mid-October. However, conditions loosened last week and are now back to being the loosest since mid-March 2022, right before the Fed started hiking rates. So much for the market doing the heavy lifting. And with yields falling and equities rising further this week, we expect financial conditions to continue loosening until the Fed and the markets reset.

No wonder the U.S. economy remains fairly robust. The Atlanta Fed's GDPNow estimate remained steady at 2.1% SAAR yesterday. It will be updated next Wednesday after the retail sales data. The New York Fed’s Nowcast model will be updated tomorrow and stands at 2.41% SAAR currently vs. 2.79% previously. If we get another reading above 2% in Q4, it would be the sixth straight quarter of above trend growth at a time when the Fed is trying to get below trend growth in order to lower inflation.

Fed hawks continue to speak up. Jefferson said “As Chair Powell mentioned in a speech in 2018, there are two particularly important cases in which doing too little when there is high uncertainty comes with higher costs than doing too much.” Kashkari said "If the labor unions are able to negotiate pretty strong pay packages — especially multi-year strong pay packages — that tells me, OK, the labor market is pretty tight and is still in favor of labor.” WIRP suggests only 15% odds of a hike December 13, rising modestly to 25% January 31. These odds are higher than they were at the start of this week but still remain too low. More importantly, the first cut is about 75% priced in for June 12. We continue to believe that this dovish rate path is very unlikely given how persistent price pressures have been.

Some are sticking to their dovish stance. Harker said “With monetary policy, there are always lags. Holding the rate steady will give those lags time to catch up.” With regards to rising yields at the long end, Goolsbee noted that "If that is sustained, the Fed will have to think about the tightening impact of those credit conditions on economic performance, and would there be dangers of overshooting." The hawks and doves will continue to battle it out but really, it will be the data that markets need to listen to. Bostic, Barkin, Paese, and Powell speak today.

Cleveland Fed President Mester will retire in June 2024. She is one of the leading hawks on the FOMC right now. More importantly, she will be a voter in 2024 and so the choice of her replacement will be closely watched. Regional Fed Presidents are chosen by each bank's board, not the President of the U.S.A.

Weekly jobless claims will be the only data reported. Initial claims are expected at 219k vs. 217k last week, while continuing claims are expected at 1.825 mln vs. 1.818 mln last week. While there have been recent signs of softening in the labor market, it remains relatively robust. There is no Bloomberg consensus yet for November NFP but its whisper number currently stands at 152k.

Banco de Mexico is expected to keep rates steady at 11.25%. Hawkish comments from bank officials suggest it is in no hurry to cut rates. The swaps market is pricing in steady rates over the next three months followed by 25 bp of easing over the subsequent three months. Ahead of the decision, Mexico reports October CPI. Headline is expected at 4.26% y/y vs. 4.45% in September, while core is expected at 5.49% y/y vs. 5.76% in September. If so, headline would be the lowest since February 2021 and nearing the 2-4% target range.

Peru central bank is expected to cut rates 25 bp to 7.0%. At the last meeting October 5, the bank cut rates 25 bp for the second straight meeting but warned that “This decision doesn’t necessarily imply a cycle of successive reductions in the interest rate. The board reaffirms its commitment to taking the necessary action to ensure that inflation returns to its target range over the forecast horizon.” Since then, October CPI came in much lower than expected. Bloomberg consensus sees a year-end rate of 6.75%, 6.0% at the end of Q1, and 5.25% at the end of Q2.

EUROPE/MIDDLE EAST/AFRICA

ECB officials continue to push back against the dovish market narrative. Guindos said “We will see how things evolve month by month, but our approach now is to keep interest rates at this level long enough to reach our target. Any discussion about lowering interest rates is clearly premature.” Villeroy said “It’s too soon to talk about a cut. But the day of a rate cut will come when everyone is convinced that inflation will come back to 2%.” Lane didn’t speak about interest rates but warned that the ECB must be careful not to withdraw too much liquidity as past polices are unwound. Yet ECB tightening expectations remain subdued. WIRP sees no odds of a hike December 14. After that, only cuts are priced and the first one is around 70% priced in for April 11 and fully priced in for June 6. Lagarde speaks later today.

BOE chief economist Pill remains in full dove mode. Specifically, he said that “Having established monetary policy in restrictive territory, it is not the case that we need to raise rates in order to bear down on inflation. Sustaining rates at their current level will continue to bear down inflation.” He added that “It is that maintaining of the restrictive stance that is key to achieving the inflation target.” Yet earlier this week, Pill said that market expectations for rate cuts by mid-2024 were not “totally unreasonable.” WIRP now suggests 10% odds of a hike December 14, rising mostly to top out near 20% February 1. The first cut is priced in for August 1.

National Bank of Poland delivered a hawkish surprise yesterday. It kept rates steady at 5.75% vs. an expected 25 bp cut. The bank also raised its 2023 inflation forecast modestly and cut its 2024 inflation forecast. Governor Glapinski will hold a press conference today to explain the decision. Whatever he says, the quick pivot to hawkishness after the general elections will simply solidify suspicions that the surprise 75 bp cut September 6 was meant to help the ruling party at the polls. Tomorrow, the bank will release its quarterly inflation report and the minutes from the October 4 meeting, when it cut rates 25 bp.

ASIA

Bank of Japan released the summary of its opinions from its October 30-31 meeting. At last week’s meeting, the BOJ kept rates steady but tweaked Yield Curve Control once again. One board member said the tweak was favorable for “smoothly proceeding with the normalization of monetary policy while maintaining monetary easing after the future exit.” Another said the sustainable 2% inflation target “seems to have risen further since the July policy meeting,” adding “It will be necessary for the bank to gradually adjust the degree of monetary easing down from its maximum level.” Another said the bank needs “to provide communication to the market in preparation for a ‘world where interest rates exist’ since interest rates have been low for so long.”

This is a clear change in tone from previous meetings. With so many board members openly talking about normalization of policy, it seems clear to us that the BOJ is seriously contemplating ending negative rates next year. With strict YCC effectively ended, the 10-year JGB yield should resume its rise and we still look for liftoff either March 19 or April 26. Simply put, Japan needs neither YCC nor negative rates anymore.

Governor Ueda sounded more dovish. With regards to the inflation target, he warned that “In the case of overshooting, I think we will be able to deal with it by raising interest rates. In the case of undershooting, it will be rather difficult to deal with it, given the effective zero lower bound on interest rates and other constraints or problems with non-traditional monetary policy measures.” Ueda noted that hiking rates will pose a “serious challenge” as the BOJ must consider the impact on private banks, borrowers, and aggregate demand. He stressed “We will have to proceed fairly carefully because everybody is used to the environment of low interest rates.”

September current account data are worth discussing. The adjusted surplus came in at JPY2.01 trln vs. JPY2.3 trln expected a revised JPY1.5 trln (was JPY1.63 trln) in August. However, the investment flows will be of more interest. The September data showed that Japan investors remained net buyers of U.S. bonds (JPY3.3 trln) for the second straight month and four of the past five months. Japan investors turned net sellers (J-PY21 bln) of Australian bonds after six straight months of net buying, and remained net sellers of Canadian bonds (-JPY155 bln) for the third straight month and for eight of the past nine months. Investors remained net sellers of Italian bonds (-JPY201 bln) for the second straight month after two straight months of net buying. Japan investors remained total net buyers of foreign bonds (JPY3.18 trln) again and for four of the past five months. With Japan yields moving higher, it’s possible that Japan investors will stop chasing higher yields abroad but it’s still too early to say.

China reported soft October CPI and PPI data. CPI came in a tick lower than expected at -0.2% y/y vs. 0.0% in September, while PPI came in a tick higher than expected at -2.6% y/y vs. -2.5% in September. The economy is likely to continue struggling with deflation well into next year, as modest stimulus measures taken so far are already starting to wear off. With rising risks of persistent deflationary pressures, we expect further stimulus measures in the coming months.