- The dollar continues to rally despite the drop in U.S. yields; weekly Chicago Fed Financial Conditions Index will be reported; the House of Representatives remains without a Speaker; BOC is expected to keep rates steady at 5.0%
- Germany reported firm October IFO business climate survey; eurozone reported September M3 data
- Japanese life insurance companies are set to increase holdings of yen-denominated bonds; Australia CPI data ran hot; Chinese developer Country Garden was deemed to be in default on its external debt
The dollar is gaining despite the drop in U.S. yields. DXY is trading higher for the second straight day near 106.466 after three straight down days. After this period of consolidation is over, we expect a test of the October high near 107.348. The euro trading lower near $1.0575 while sterling is trading lower near $1.2125. USD/JPY is trading flat just below 150 despite reports that Japan life insurers plan to increase holdings of yen-denominated debt (see below). We believe the recent dollar weakness was corrective in nature. Looking beyond the current noise related to dovish Fed comments and some well-publicized investor calls in USTs, nothing fundamentally has changed and we see no reason to believe the dollar’s uptrend has ended. Simply put, the U.S. economy continues to grow above trend even as the rest of the world slips into recession. Recent data confirm that the U.S. economy is still running hot and needs further tightening.
AMERICAS
The dollar continues to rally despite the drop in U.S. yields. Last week, with U.S. yields hitting new highs, we found the lack of dollar strength is puzzling. This week, with U.S. yields well off those highs, the return of dollar strength is not as puzzling. Simply put, the economic data this week underscore just how weak the rest of the world is while the U.S. continues to grow well above trend. Eurozone and U.K. composite PMIs remained below 50 in October, while Japan and Australia joined them in the sub-50 club. When all is said and done, we think the case for a stronger dollar remains in place.
S&P Global preliminary October PMIs came in firm. Headline manufacturing came in at 50.0 vs. 49.5 expected and 49.8 in September while services came in at 50.9 vs. 49.9 expected and 50.1 in September. As a result, the composite PMI came in at 51.0 vs. 50.0 expected and 50.2 in September. It's the first rise in the S&P Global composite since May but this series has been underperforming the ISM series in recent months. ISM will be reported next week, with manufacturing expected at 48.6 vs. 49.0 in September and services expected at 53.0 vs. 53.6 in September.
Weekly Chicago Fed Financial Conditions Index will be reported. The previous reading through Friday October 13 was the loosest since early March 2022, before the Fed started hiking rates. So far, higher bond yields do not appear to be having much impact on financial conditions. No wonder the economy continues to power on.
The final Q3 update of the Atlanta Fed’s GDPNow model comes today after the data. The model is currently tracking growth at 5.4% SAAR. September new home sales are expected at 0.7% m/m vs. -8.7% in August. We then get our first official reading for Q3 GDP tomorrow. Consensus sees growth at 4.5% SAAR vs. 2.1% in Q2, with personal consumption expected at 4.0% SAAR vs. 0.8% in Q2. The Atlanta Fed’s model will then begin tracking Q4 growth with its first estimate Friday.
The House of Representatives remains without a Speaker. After Republicans yesterday selected Tom Emmer to be Speaker after several rounds of voting by secret ballot, he withdrew from the race after four hours when it became clear he did not have the 217 votes needed to become Speaker. Another secret ballot was held last night and Mike Johnson became the new nominee. The Republicans plan to hold another floor vote today but Johnson may also lack the 217 votes too. The longer the House remains without a speaker, the higher the odds that it won’t be able to pass the necessary budget bills to avoid a shutdown when the Continuing Resolution expires November 17. There are reports that some Republicans are privately signaling support for a resolution that would giving Acting Speaker McHenry the ability to reopen the House and pass legislation until January 3 2024.
Bank of Canada is expected to keep rates steady at 5.0%. After it last hiked rates July 12, the bank paused at the last meeting September 6 but said it was prepared to hike again if needed. Since then, September CPI came in lower than expected at 3.8% vs. 4.0% in August. It was the first deceleration since June but remains well above the 2% target. Updated macro forecasts will be released at this meeting. Of note, WIRP suggests less than 10% odds of a hike, rising to 20% December 6 and topping out near 35% March 6. A rate cut is not priced in until Q4 2024. Of note, CAD has gained the past four BOC decision days.
EUROPE/MIDDLE EAST/AFRICA
Germany reported firm October IFO business climate survey. Headline came in at 86.9 vs. 86.0 expected and a revised 85.8 (was 85.7) in September. This was the first increase in the headline since April but remains well below that month’s peak of 93.2. Current assessment came in at 89.2 vs. 88.5 expected and 88.7 in September, while expectations came in at 84.7 vs. 83.5 expected and a revised 83.1 (was 82.9) in September.
Eurozone reported September M3 data. M3 came in at-1.2% y/y vs. -1.8% expected and -1.3% in August. This was the first improvement since August 2022 but the ongoing contraction still bodes ill for the economic outlook. Recall that the European Central Bank’s quarterly lending survey reported yesterday showed that banks continued to toughen internal guidelines and approval criteria for businesses loans, mortgages, and other consumer credit.
European Central Bank meets Thursday and is expected to keep rates steady. While there are still a handful of hawkish holdouts, most ECB policymakers have acknowledged that the tightening cycle is over. The bank is expected to discuss modifications to reserve requirements as well has how to shrink its PEPP holdings but no decisions are expected until next year. However, some fear a surprise hike this week in the so-called Minimum Reserve Requirement from 1% currently, which would hurt bank earnings. Updated macro forecasts won’t come until the December 14 meeting. Of note, WIRP suggests no odds of a hike this week, rising to top out at only 10% December 14. A rate cut is nearly priced in for June 6.
ASIA
Nippon Life Insurance said it plans to increase its holdings of yen-denominated bonds. At the same time, it plans to keep its holding of foreign debt (both with and without currency hedges) either flat or lower in H2 FY23 ending March 2024. The insurer has an investment portfolio of JPY75 trln ($500 bln). While it plans to selectively sell lower-yielding foreign bonds due to high hedging costs, the company said it plans to add foreign corporate bonds with attractive returns over the medium- to long-term on the view that hedging costs will eventually fall. Nippon official noted “Hedging costs will probably fall in the medium to long term and if you buy 10-year A or BBB-rated foreign debt that offers more than 6% return, then they are relatively more attractive than JGBs by holding on to maturity.”
This comes just a day after Japan Post Insurance said that it also plans to increase its holding of yen-denominated bonds. Similarly, it plans to lighten up on its foreign debt holdings due to high currency hedging costs as well as expectations for a stronger yen in the fiscal second half. Japan Post official said “Our basic stance is to shift our holdings to yen-denominated bonds,” adding that the 30-year JGB yield relative to returns from foreign bonds with currency hedges is “looking attractive” and that “we will gradually start purchases as yen bond returns have risen to quite attractive levels.”
This is one of the expected outcomes from the end of YCC. With YCC gone, JGB yields should rise enough to lead to significant shifts in portfolio flows. Under ZIRP and later YCC, Japan investors were forced to look abroad for higher fixed income returns. That will clearly reverse, but the question is one of magnitude. We believe the impact won’t be hugely significant because the BOJ’s expected tightening path is likely to be very gradual. Of note, the swaps market is pricing in only 75 bp of tightening over the next three years.
Australia CPI data ran hot. September CPI came in at 5.6% vs. 5.3% expected and 5.2% in August. It was the second straight month of acceleration to the highest since April and further above the 2-3% target range. Elsewhere, Q3 CPI came in at 5.4% y/y vs. 5.3% expected and 6.0% in Q2, while trimmed mean came in at 5.2% y/y vs. 5.0% expected and 5.9% in Q2. Q3 PPI data will be reported Friday. RBA tightening expectations picked up sharply as a result. WIRP suggests 55% odds of a hike November 7 vs. 20% at the start of this week, rising to 80% December 5 vs. 40% at the start of this week. A hike is fully priced in for February 6 along with nearly 20% odds of a second hike. Those odds are new and top out around 33% in Q2. A rate cut is not priced in until 2025.
Chinese developer Country Garden was deemed to be in default on its external debt. The trustee acknowledged that company had failed to pay $15.4 mln of interest due on a dollar-denominated bond by the end of the 30-day grace period after it missed the initial deadline of September 17. A default was expected after Country Garden last week announced that it didn’t expect to meet its external debt obligations. We assume talks with creditors will now begin with regards to debt restructuring. With China suffering from a huge debt overhang and other companies expected to default, we simply can’t get excited about recently announced plans to issue more debt to boost the economy. This is simply adding to the pile of existing debt that is nearing 300% of GDP.
