• U.S. yields dropped sharply after the surprise CPI readings; several Fed speakers seem willing to slow the pace of hikes after CPI; future Fed decisions remain data dependent; the semiannual U.S. Treasury Department FX report gave a pass to recent BOJ intervention; preliminary November University of Michigan consumer sentiment will be the highlight
  
• The EU updated its macro forecasts; ECB tightening expectations have been pared back; the monthly U.K. data dump began; BOE tightening expectations need to adjust lower
  
• Japan reported October PPI; China eased some Covid Zero restrictions; PBOC said it will maintain a reasonable rate of growth in money and credit
  

The dollar has suffered significant technical damage. While we disagree with the market’s dovish take on the Fed, we have to respect the price action as many major chart points have been broken across virtually every major currency. This signals further near-term dollar weakness. DXY broke above its September 13 low near 107.68 and sets up a test of the August 10 low near 104.636. The euro broke above its September 12 high near $1.02 and sets up a test of the August 10 high near $1.0370. Cable broke above its September 13 high near $1.1740 and sets up a test of the August 26 high near $1.19. USD/JPY broke below its September 22 low near 140.35 and sets up a test of the August 23 low near 135.80.

AMERICAS

U.S. yields dropped sharply after the surprise CPI readings. The 2-year yield traded as low as 4.29% yesterday vs. the 4.80% cycle peak from last week. The 10-year yield traded as low as 3.81% yesterday vs. the 4.34% cycle peak from last October. The U.S. bond market is closed today for holiday but yields seem likely to continue probing the downside until the data says otherwise. As a result, the dollar is also likely to remain under near-term pressure.

October CPI data are worth discussing. Headline came in at 7.7% y/y vs. 7.9% expected and 8.2% in September and was the lowest since January. Elsewhere, core came in at 6.3% y/y vs. 6.5% expected and 6.6% in September and was the lowest since August. There was a statistical quirk at the heart of the downside miss, as health insurance costs fell 4.0% m/m due to the way it’s calculated as a residual. PCE uses a different method and so it is unlikely to see a similar fall. Of note, the Owners’ Equivalent Rent (OER) component rose a cycle high 6.9% y/y and so we’re not seeing any impact yet of the slumping housing market. October PPI will reported next Tuesday. Headline is expected at 8.3% y/y vs. 8.5% in September, while core is expected to remain steady a 7.2% y/y.

Several Fed speakers seem willing to slow the pace of hikes after the CPI data. Logan said “While I believe it may soon be appropriate to slow the pace of rate increases so we can better assess how financial and economic conditions are evolving, I also believe a slower pace should not be taken to represent easier policy.” She added that “This morning’s CPI data were a welcome relief, but there is still a long way to go.” Elsewhere, Daly said “Stepping down is an appropriate thing to think about. Pausing is not the discussion, the discussion is stepping down.” She added that “I support a more gradual approach to getting to it so we can be discovering the right rate as we go.” Harker said “In the upcoming months, in light of the cumulative tightening we have achieved, I expect we will slow the pace of our rate hikes as we approach a sufficiently restrictive stance.” He added that “But I want to be clear: A rate hike of 50 bp would still be significant.” George said “A more measured approached to rate increases may be particularly useful as policymakers judge the economy’s response to higher rates.” She added that “Already, the Federal Open Market Committee’s policy actions have led to a sharp tightening of financial conditions.” Lastly, Mester said “Now the focus can shift to the appropriate level of restrictiveness that will return the economy to price stability in a timely way. I believe monetary policy will need to become more restrictive and remain restrictive for a while.”

Future Fed decisions remain data dependent. Before the December 13-14 meeting, we will get one more each of the jobs report, CPI, core PCE, and retail sales along with two more PPI reports. WIRP now suggests a 50 bp hike remains fully priced in but no longer any odds (for now) of a larger 75 bp move. The swaps market is pricing in a terminal rate near 5.0%, down from the 5.25% peak earlier this month. We stress that getting inflation from 8% to 4% is the easy part. Getting it from 4% to 2% is the hard part and that is where the pain lies.

The semiannual U.S. Treasury Department FX report gave a pass to recent Bank of Japan intervention. Treasury Secretary Yellen issued a statement that “Treasury is cognizant that a range of approaches by developing and emerging economies to global economic headwinds may be warranted in certain circumstances.” In the Japan section, the report noted that “Treasury’s firm expectation is that in large, freely traded exchange markets, intervention should be reserved only for very exceptional circumstances with appropriate prior consultations.” Treasury refrained from designating any major U.S. trading partner as a currency manipulator. Of note, Switzerland continued to meet all three criteria for potential unfair currency practices, while seven others were on the Treasury’s so-called monitoring list for meeting some of the criteria: China, Japan, Korea, Germany, Malaysia, Singapore and Taiwan. All seven were on the list in the June report, though Vietnam fell of the list this time.

Preliminary November University of Michigan consumer sentiment will be the highlight. The headline is expected to fall a few ticks to 59.5, driven by falls in both current conditions and expectations to 62.8 and 55.5, respectively. If so, it would be the first drop in the headline since June, when it bottomed at 50.0. Of note, 1-year inflation expectations are expected to pick up a tick to 5.1%, while 5-year expectations are expected to remain steady at 2.9%. October retail sales will be watched for signs of weakness if sentiment worsens.

EUROPE/MIDDLE EAST/AFRICA

The European Union updated its macro forecasts. Eurozone growth is seen at 3.2% this year but slowing sharply to 0.3% next year vs. 1.4% previously. Growth is expected to recover to 1.5% in 2024. Inflation is seen at 8.5% this year, up nearly a percentage point from the previous forecast. Inflation is expected to slow to 6.1% next year vs. 4.0% previously, and then to 2.6% in 2024. The EU noted that “Amid elevated uncertainty, high energy price pressures, erosion of households’ purchasing power, a weaker external environment and tighter financing conditions are expected to tip the EU, the euro area and most member states into recession. Broadening price pressures are expected to have moved the inflation peak to year-end.” It added that “The largest threat comes from adverse developments on the gas market and the risk of shortages, especially in the winter of 2023-24.”

ECB tightening expectations have been pared back. WIRP suggests another 75 bp is about 45% priced in for December 15 vs. fully priced in after the October decision, while the swaps market is pricing in a peak policy rate near 3.0% vs. 3.5-3.75% after the October decision. Of note, the updated EU forecasts bring it closer into line with the ECB’s September forecasts. However, the ECB will update its forecasts at the December meeting and are likely to see similar revisions as the EU. 2025 will be added to the forecast horizon then. Holzmann, Panetta, Guindos, Lane, de Cos, Centeno, and Nagel all speak today. We think there is still room for ECB tightening expectations to fall further and stand by our call that the ECB will pivot and cut rates before the Fed does. We also think this holds true for the BOE as the recession has already started (see below).

The monthly U.K. data dump began. Q3 growth came in at -0.2% q/q vs. -0.5% expected and 0.2% in Q2, which translated into a y/y rate of 2.4% vs. 2.1% expected and 4.4% in Q2. This is just the beginning, as the Bank of England has warned that the recession had already started and would likely last two years. Of note, strong government spending, GFCF, and net exports all boosted the overall number and those components are likely to be large drags in Q4 and beyond. Construction came in at 0.4% m/m vs. -0.6% expected and a revised 0.6% (was 0.4%) in August, IP came in at 0.2% m/m vs. -0.3% expected and a revised -1.4% (was -1.8%) in August, services index came in at -0.8% m/m vs. -0.5% expected and a revised 0.1% (was -0.1%) in August, and the trade balance came in at -GBP3.1 bln vs. -GBP7.0 bln expected and a revised -GBP4.7 bln (was -GBP7.1 bln) in August.

BOE tightening expectations need to adjust lower. After its dovish message last week, WIRP suggests 45% odds of another 75 bp hike December 15. The swaps market is now pricing in 150 bp of tightening over the next 12 months that would see the policy rate peak near 4.5%. This is down from 4.75% at the start of this week and down sharply from 6.25% right after the mini-budget in late September. Haskel and Tenreyro speak today. Of note, Tenreyro voted for a 25 bp cut last week and so her comments should tilt dovish.

ASIA

Japan reported October PPI. It came in at 9.1% y/y vs. 8.8% expected and a revised 10.2% (was 9.7%) in September. That revised September reading was the highest in 42 years. It’s tempting to say PPI has peaked but if the drop is sustained, that bodes well for CPI in the coming months. October national CPI will be reported next Friday. Headline is expected to jump 3.7% y/y vs. 3.0% in September, while core is expected to jump 3.5% y/y vs. 3.0% in September. In a sign that inflation is becoming more broad-based, core ex-energy is expected at 2.4% y/y vs. 1.8% in September. Yet the BOJ shows no signs of pivoting under Governor Kuroda. Next policy meeting is December 19-20 and no change is expected then.

China eased some Covid Zero restrictions. Travelers to China will now have to quarantine five days in a hotel or government facility vs. five previously, followed by the same three days at home. The shortened quarantines will also be applied to close contacts of infected people, while close contacts of close contacts will no longer be identified. As reported earlier this month, the penalty for airlines bringing any infected people into China will be eliminated. The timing of the moves is noteworthy as virus cases nationwide are at a 6-month high, which suggests that policymakers are trying to minimize the disruptions from Covid Zero. That said, we don’t want to get too excited as the overall policy remains in place even as most other countries have moved on. What’s key is China’s next steps (if any) toward eliminating the controversial policy altogether.

The People’s Bank of China said it will maintain a reasonable rate of growth in money and credit. In an official notice published today, the bank said it would step up its support for key sectors to stabilize the economy and to help the recovery of sectors hurt by the pandemic. This comes after weaker than expected October new loan and aggregate financing data were reported this week. The bank is walking a fine line between stimulus and financial instability as too much credit-fueled activity was the ultimate source of the current property market slump.