- Friday’s jobs data validated the Fed’s hawkish stance; the rise in U.S. yields has stalled; many Fed speakers will spread the word this week; future Fed decisions remain data dependent
- ECB tightening expectations have been pared back; Germany reported firm September IP; BOE tightening expectations still need to adjust lower
- Japan will reportedly have to issue only JPY5.0 trln in FY22 to finance the JPY29.1 extra budget announced last week; China reported weak October trade data
The dollar remains under pressure as the new week begins. DXY is down for the second straight day and is currently trading near 110.50. The euro rally stalled out near $1.00 as further gains will be difficult given the negative fundamental backdrop there. Sterling has recouped most of its post-BOE losses but is having trouble breaking above $1.15. The yen has held on to most of its recent gains as USD/JPY is trading near 146.50. The dollar bloc is underperforming today as China official comments suggest no end to Covid Zero (see below). We remain puzzled by the lack of follow-through buying for the dollar as last week’s combination of a hawkish Fed and strong U.S. data. The ongoing repricing of the Fed tightening path is likely to see the dollar recover after this recent correction. Much will depend on the Fed and how the U.S. data come in but so far, the signs still remain positive for the greenback.
AMERICAS
Friday’s jobs data validated the Fed’s hawkish stance. The expected market reaction should have been higher bond yields, lower equities, and a stronger dollar. And that’s what we got, for about an hour. This trade then unraveled quickly and the exact opposite happened for the rest of the day. Sometimes, there are just days when the price action can’t be explained by fundamental developments and that’s what happened Friday. For the week ahead, we continue to believe that markets should stay focused on the fundamentals, which have not changed and remain dollar-supportive.
The rise in U.S. yields has stalled. The 2-year yield traded at a new cycle high near 4.80% Friday and was the highest since July 2007. It ended last week lower and is currently trading near 4.68%. The 10-year yield traded near 4.22% last week but has fallen to 4.14% today and remains below the October 21 cycle high near 4.34%. If the Fed continues to hike aggressively as we expect, U.S. yields should resume climbing. It’s worth noting that the 2-yaer differentials with Japan and the U.K. are at cycle highs, while the differential with Germany has fallen back a bit after peaking near 196 bp last week.
Many Fed speakers will spread the word this week. Collins, Mester, and Barkin speak today. Last Friday, Collins said that recent data have “broadened” her view on peak rates and added that rates may need to go higher than she expected in September. However, she added that it makes sense to move more slowly in order to balance the risks. Also on Friday, Barkin said it’s “conceivable” that rates end up above 5% as she sees a potentially higher terminal rate. He said he’s unsure of the December meeting as more data is still coming in. Both are expected to maintain this tone, which is entirely consistent with Powell's message last Wednesday. Since the August Jackson Hole Symposium, the Fed has been incredibly consistent in its communications.
Future Fed decisions remain data dependent. We will get one more jobs reports and two sets of inflation and retail sales data before the December 13-14 meeting. WIRP suggests a 50 bp hike then is fully priced in, with 25% odds of a larger 75 bp move. The swaps market continues to price in a terminal rate between 5.0-5.25%. October CPI data Thursday will be this week’s highlight. Today, only September consumer credit will be reported and is expected at $30.0 bln vs. $32.24 bln in August.
EUROPE/MIDDLE EAST/AFRICA
ECB tightening expectations have been pared back. WIRP suggests another 75 bp is about 55% priced in for December 15 vs. fully priced in after the October decision, while the swaps market is pricing in a peak policy rate between 3.0-3.25% vs. 3.5-3.75% after the October decision. There will be many ECB speakers this week. Villeroy sounded more hawkish than usual as he said “As long as underlying inflation has not clearly peaked, we shouldn’t stop on rates.” However, he added that “It’s too early to tell where the end point in interest rates, or the so-called terminal rate, could be. That said we are not far from the neutral rate, beyond which our hiking pace could be more flexible and possibly slower.” Lagarde and Panetta also speak today.
Germany reported firm September IP. IP came in at 0.6% m/m vs. 0.1% expected and a revised -1.2% (was -0.8%) in August. As a result, the y/y rate rose to 2.6% y/y vs. 2.0% expected and a revised 1.6% (was 2.1%) in August. Last week’s soft factory orders reading (-4.0% m/m) suggests little relief for the German manufacturing sector in the coming months. Germany remains the weak link in the eurozone and this data does little to change that.
BOE tightening expectations still need to adjust lower. After its dovish message last week, WIRP suggests 60% odds of another 75 bp hike December 15. The swaps market is still pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 4.75%. This is down sharply from 6.25% right after the mini-budget in late September, but it seems that this should move even lower after the BOE decision. Perhaps markets are waiting for more details of Chancellor Hunt’s budget statement due out November 17 before committing to lower rates.
ASIA
Japan will reportedly have to issue only JPY5.0 trln in FY22 to finance the JPY29.1 extra budget announced last week. It appears much of the budget will be financed by unused fiscal investment and loan program bonds as well as refinancing existing bonds. Much of the new issuance will reportedly be concentrated in the short end of the curve, where rates remain low due to Yield Curve Control. Still, total JGB issuance looks set to rise above JPY200 trln for the third straight FY. The fact that the government announced yet another fiscal package to boost growth supports our belief that officials are too concerned about growth to remove monetary accommodation anytime soon.
China reported weak October trade data. Exports came in at -0.3% y/y vs. at 4.5% expected and 5.7% in September, while imports came in at -0.7% y/y vs. flat expected and 0.3% in September. This was the first y/y drop in exports since May 2020 and the first y/y drop in imports since August 2020. Clearly, the regional slowdown is only getting worse. Over the weekend, senior National Health Commission official spoke about Covid Zero and said “Previous practices have proved that our prevention and control plans and a series of strategic measures are completely correct. The policies are also the most economical and effective.” As such, we expect the uneven and weak recovery to continue for now.