• U.S. yields continue to rise; with U.S. 10-year yield moving higher, the 2- to 10-year yield curve could actually un-invert; a government shutdown is looking more and more likely; weekly jobless claims will be of interest; Mexico is expected to keep rates steady at 11.25%; even high carry is providing little protection in this strong dollar environment
  
• September eurozone CPI readings have started rolling out; one ECB hawk is pushing for a massive increase in reserve requirements; eurozone retail sales data for August continue rolling out; BOE announced it has begun work on a new financial stability tool
  
• BOJ report suggests that YCC may have helped push up corporate spreads; Australia reported soft August retail sales

The dollar is trading lower as a much-needed correction takes hold. After making a new cycle high yesterday near 106.839, DXY is trading lower near 106.400 after six straight up days. After this correction runs its course, we believe DXY is on track to test the November 30 high near 107.195 and then the November 21 high near 108. The euro is trading higher near $1.0540 after making a new cycle low yesterday near $1.0490, the weakest since January 6. The next target is the November 30 low near $1.0290. Sterling is trading higher near $1.22 after making a new cycle low yesterday near $1.2110, the weakest since March 17. The next target is that month's low near $1.1805. USD/JPY is trading lower near 149.30 after making a new cycle high yesterday near 149.70, the highest since October 24. The next target is that month's high near 152. We view today’s dollar weakness as corrective in nature; the fundamental story remains in favor of the greenback as the U.S. economy is in a much stronger position than the other major economies such as the eurozone or the U.K. With firm U.S. data expected to lead to an adjustment higher in Fed tightening expectations, we look for further dollar strength.

AMERICAS

U.S. yields continue to rise. The 10-year yield traded near 3.72% July 19 and traded near 4.64% today, while the 30-year yield traded near 3.83% July 19 and traded near 4.76% today. It's worth noting that this most recent run up in U.S. yields began in August, right after the much higher than expected quarterly refunding announcement on July 31. So the punchline, we think, is that supply is a big part of this move up in yields. Add in persistent U.S. inflation and a still robust U.S. economy and one can easily make a case for a 5-handle on long dated U.S. Treasuries.

With the U.S. 10-year yield moving higher, the 2- to 10-year yield curve could actually un-invert. At -49 bp currently, it's the least inverted since mid-May. If the 10-year yield were to rise to the June 2007 high near 5.32% and the 2-year yield were to stay more or less steady, voila! We would get a positively sloped 2- to 10-year curve. The 3-month to 10-year curve has a longer way to go at -83 bp currently but one never knows.

Besides nominal yields, real yields continue to move in the dollar’s favor. The U.S. 10-year real yield traded near 2.30% Today, another cycle high. U.K. and Germany real yields are moving higher too but the gap remains wide. Japan is an outlier and remains stuck at -50 bp. The FX market has taken its cue from the rates market and continues to take the dollar higher, as DXY bottomed July 14 and has risen over 7% since. Indeed, DXY has gained every week since that bottom for a streak of ten straight. Despite today’s much needed correction, these trends should continue.

Despite the big moves in yields, Fed tightening expectations have yet to adjust significantly higher. WIRP suggests only 25% odds of a hike November 1, rising to 50% December 13 and nearly 55% January 31. These odds are way too low given the Fed’s hawkish stance and should move higher if the data remain firm, as we expect. Fed officials are likely to push the higher for longer narrative this week. Goolsbee, Cook, Powell, and Barkin speak all speak today. Goolsbee and Barkin are in the dovish wing while Powell and Cook are seen as centrists.

A government shutdown is looking more and more likely. After the Senate floated a bipartisan plan Tuesday to keep the government funded through mid-November, Republican House Speaker McCarthy said he would not hold a House vote on it. As a result, it’s now very possible that the current funding laws will expire at 1201 AM ET this Sunday, which would trigger a shutdown. Like the auto strike, what really matters is the duration.

Regional Fed surveys for September will continue rolling out. Kansas City Fed manufacturing survey (-2 expected) will be reported today and its services survey will be reported tomorrow.

Weekly jobless claims will be of interest. That’s because continuing claims are for the BLS week containing the 12th of the month and are expected at 1.675 mln vs. 1.662 mln last week. Initial claims are expected at 215k vs. 201k last week. Last week’s reading was for the BLS survey week and the lowest since late January, while the 4-week moving average of 217k was the lowest since the February BLS survey week. NFP that month came in at 311k vs. 225k expected. Current Bloomberg consensus for September NFP is 163k while its whisper number is 172k. The unemployment rate is expected to drop a tick to 3.7%. We believe that despite the various strikes, the labor market remains very tight.

Housing data will remain in focus. Pending home sales will be reported Thursday and are expected at -1.0% m/m vs. 0.9% in July. With the national average 30-year mortgage rate still moving up to approach a new high near 7.85% this week, the housing sector is likely to show some renewed signs of weakness.

We get another revision to Q2 GDP data. Growth is expected to be revised up a tick to 2.2% SAAR. However, that’s old news and markets are looking ahead to Q3 and Q4. The Atlanta Fed’s GDPNow model is currently tracking Q3 growth at 4.9% SAAR and the next update comes tomorrow after the data.

Banco de Mexico is expected to keep rates steady at 11.25%. At the last meeting August 10, the bank kept rates steady and said it was “necessary to maintain the reference rate at its current level for an extended period.” The minutes later showed that a rate cut was not even discussed. The swaps market is now pricing in steady rates over the next six months followed by 50 bp of easing over the subsequent six months.

Brazil reports August central government budget data. A primary deficit of -BRL26.0 bln is expected vs. -BRL35.9 bln in July. Consolidated budget data will be reported tomorrow and a primary deficit of -BRL25.1 bln is expected vs. -BRL35.8 bln in July. The central bank also releases its quarterly inflation report. We believe part of the central bank’s cautiousness in easing is due to the deteriorating fiscal trajectory.

Even high carry is providing little protection in this strong dollar environment. Over the past five days, the worst EM performers have been COP, MXN, HUF, CLP, BRL, and PEN, all high yielders. Of note, USD/BRL traded near 5.08 yesterday, the weakest since May 31 and on track to test that day’s high near 5.1270. Break above that would set up a test of the March high near 5.34. This weakness, if sustained, should cement the central bank’s cautious approach to easing.

EUROPE/MIDDLE EAST/AFRICA

September eurozone CPI readings have started rolling out. Spain’s EU Harmonised inflation came in a tick lower than expected at 3.2% y/y vs. 2.4% in August. Spain is one of the few eurozone countries to report core inflation and it fell two ticks more than expected to 5.8% y/y vs. 6.1% in August. Germany will report later today and is expected at 4.5% y/y vs. 6.4% in August. German state data already reported today suggest slight downside risks to the national reading. France and Italy report tomorrow. France’s EU Harmonised inflation is expected at 5.9% y/y vs. 5.7% in August, while Italy’s is expected at 5.4% y/y vs. 5.5% in August. Eurozone reports later tomorrow. Headline is expected at 4.5% y/y vs. 5.2% in August, while core is expected at 4.8% y/y vs. 5.3% in August. If so, headline would decelerate for the fifth straight month to the lowest since October 2021 and would feed into the dovish ECB narrative.

One ECB hawk is pushing for a massive increase in reserve requirements. The ECB is expected to debate this and adjustments to its bond-buying program at the October 26 meeting. However, it appears the public debate has begun in earnest and Holzmann has staked out a rather extreme position. With current reserves requirements for banks at 1% of customer deposits, Holzmann said yesterday that “I’m thinking about 5-10%” while acknowledging that “this will lead to an outcry from the banks.” He explained his position by noting “Banks benefited significantly from unconventional monetary policy during the crisis. If we’re forced to take similar measures again in the future, we’ll need reserves in our balance sheet. I therefore suggest the banks deposit more money with us without interest as minimum reserves.” Before 2011, the rate stood at 2% and so we very much doubt Holzmann’s wish will be anywhere close to being met.

Mopping up liquidity and the duration of current interest rates will obviously be the two biggest decisions for the ECB for this coming year. WIRP suggests around 5% odds of a hike October 26, then rising modestly to top out near 20% December 14. The first cut is still seen around mid-2024. Holzmann and de Cos speak.

Eurozone retail sales data for August continue rolling out. Spain reported today at 7.2% y/y vs. 7.3% in July. Germany reports tomorrow and is expected at 0.5% m/m vs. -1.0% in July. France already reported weak sales for August. Eurozone sales won’t be reported until October 4, while Italy reports retail sales October 6.

The Bank of England announced it has begun work on a new financial stability tool. BOE Executive Director for Markets Andrew Hauser said the bank is working “to build a new central bank backstop tool capable of lending directly to NBFIs (Non-Bank Financial Institutions) against high quality assets to help tackle future episodes of severe dysfunction in core markets that threaten UK financial stability.” This program would be designed to allow the BOE to lend directly to insurance companies and pension funds. Hauser made sure to say this would cover Liability Driven Investment (LDI) funds, the source of last year’s disastrous Gilt market failure, in order to prevent a repeat of that. Hauser noted that since 2008, the non-bank financial system has doubled in size and already accounts for about half of total assets in the global financial system. Greene speaks later today.

ASIA

Bank of Japan report suggests that Yield Curve Control may have helped push up corporate spreads. The analysis suggests that the long end of the JGB curve was not allowed to rise and so became “distorted” even as demand for working capital and tighter global liquidity was hitting Japan. Corporate borrowers were forced to pay higher absolute borrowing costs but because the JGB curve was anchored, their spreads to risk-free paper widened in relative terms. According to Bloomberg, Japan corporate bond spreads widened around 30 bp from the start of 2022 to a high of 67.5 bp in March but have since tightened to 60.5 bp. The report noted that corporate spreads have narrowed a bit this year as the functioning of the JGB market has improved, even as the BOJ’s corporate bond-buying operations have helped push down absolute yields. It seems that this is one of the market functions that the BOJ was hoping to improve with its two tweaks to YCC this past year. Most analysts believe YCC will be eliminated in 2024 and we concur.

Australia reported soft August retail sales. Sales came in a tick lower than expected at 0.2% m/m vs. 0.5% in July. The y/y rate slowed to 1.5% vs. 2.1% in July and is the slowest since August 2021. Despite the soft sales data, RBA tightening expectations remain elevated. WIRP suggests no odds of a hike at new Governor Bullock’s first meeting October 3. However, those odds rise to nearly 35% November 7, 50% December 5, and top out near 95% in March.