Dollar Soft as U.S. Returns from Holiday

October 15, 2024

Win Thin

Fed officials remain cautious; October regional Fed surveys start rolling out; New York Fed reports September inflation expectations; Canada highlight will be September CPI data
ECB reported its Q3 Bank Lending Survey; German October ZEW survey was mixed; U.K. reported labor market data; Israel reports September CPI data
Japan Prime Minister Ishiba said he is not considering any changes in the sales tax; RBNZ Deputy Governor Hawkesby warned more easing was in the pipeline; China may raise CNY6 trln (5% of GDP) from ultra-long special government bonds
Crude oil future prices are down 5%

The dollar is soft as the U.S. returns from holiday. DXY is trading lower near 103.084 after making a new cycle high near 103.358 yesterday. The yen is outperforming and USD/JPY is trading lower near 149.15 after testing the 150 level yesterday. The euro is trading flat near $1.0910 and remains on track to test the August 1 low near $1.0780 as ECB easing expectations ramp up, while sterling is trading higher near $1.3090 after unemployment unexpectedly fell (see below). We believe the recent U.S. data and Fed comments continue to support a very gradual easing cycle (see below). Market easing expectations for the Fed have adjusted after the recent spate of strong U.S. data but are still too dovish. As the Fed repricing continues, the dollar should see another leg higher.

AMERICAS

Fed officials remain cautious. Kashkari said that “further modest reductions” in the Fed Fund rates will be appropriate in the coming quarters, adding that “Ultimately, the path ahead for policy will be driven by the actual economic, inflation and labor market data.” Previously, Kashkari has said that 25 bp cuts at the November and December FOMC meetings were a “reasonable starting point.” Waller said, “I view the totality of the data as saying monetary policy should proceed with more caution on the pace of rate cuts than was needed at the September meeting.” He added that recent data suggest the economy may not be slowing as much as desired. Daly, Kugler, and Bostic speak today.

Fed easing expectations continue to evolve. After the strong jobs data the previous week, higher than expected CPI data last week support our long-held view that the Fed is likely to maintain a very cautious approach to cutting rates. Two cuts by year-end are no longer priced in, while 125 bp of total easing is seen over the next 12 months. If the data remain strong, there is still scope for Fed easing expectations to adjust further, thereby supporting the dollar.

October regional Fed surveys start rolling out. Empire manufacturing kicks things off today and is expected at 3.6 vs. 11.5 in September. New York Fed services will be reported tomorrow. Philly Fed manufacturing will be reported Thursday and is expected at 3.5 vs. 1.7 in August.

New York Fed reports September inflation expectations. Both 1- and 5-year expectations were steady in August, while 3-year expectations picked up two ticks. We do not think inflation expectations are a significant driver for Fed policy right now.

Canada highlight will be September CPI data. Headline is expected to fall two ticks to 1.8% y/y, while core median is expected to remain steady at 2.3% y/y and core trim is expected to rise a tick to 2.5% y/y. If so, headline would be the lowest since February 2021 and in the bottom half of the 1-3% target range. Slower inflation could boost the case for a 50 bp cut at the next October 23 BOC meeting. The market is pricing in 50% odds of this jumbo cut.

EUROPE/MIDDLE EAST/AFRICA

The ECB reported its Q3 Bank Lending Survey. Overall, the survey points to a modest improvement in credit demand but does not weaken the case for a more dovish ECB policy stance. Banks reported a moderate net 4% increase in the demand for loans to enterprises. The increase was more muted than banks had expected in the previous quarter (10%). Banks reported a strong net 39% increase in the demand for housing loans. This was the highest net percentage increase since the Q2 2015 (42%) and above banks’ expectations (26%). Lastly, banks reported a net 8% increase in the demand for consumer credit and other lending to households. The is broadly in line with the previous quarter (7%) and banks’ expectations. The ECB is expected to deliver a dovish 25 bp cut Thursday because the eurozone economy is stagnating and inflation is undershooting the ECB’s 2% target.

Germany October ZEW survey was mixed. Expectations came in at 13.1 vs. 10.0 expected and 3.6 in September, while current situation came in at -86.9 vs. -84.0 expected and -84.5 in September. This was the first rise in expectations since June but remains well below that month’s peak of 47.5. ZEW President noted that the improvement was due to “the expectation of stable inflation rates and the associated prospect of further interest-rate cuts by the European Central Bank. Positive signals are also coming from Germany’s export markets.” While the increase is welcome, Germany remains the weak link in the eurozone as it slides into recession.

U.K. reported labor market data. Average weekly earnings ex-bonuses fell two ticks as expected to 4.9% y/y and largely tracks the Bank of England’s Q3 projection of 4.8% y/y. The unemployment rate unexpected fell a tick to 4.0% vs. expectations that it would remain steady for a third consecutive month and remains well below the BOE’s Q3 forecast of 4.4%. The recent U.K. data support a cautious easing cycle.

Israel reports September CPI data. Headline is expected to pick up two ticks to 3.8% y/y. if so, it would be the highest since September 2023 and further above the 1-3% target range. Last week, the Bank of Israel delivered a hawkish hold. Governor Yaron said a rate hike is possible if inflation rises more than expected. Of note, it forecasts 2024 inflation at 3.8% vs. 3.0% in July and 2025 inflation steady at 2.8%. The bank’s research department also sees the policy rate still at the current 4.5% in Q3 2025. In the July projections, the rate was seen falling to 4.25% in Q2 2025. Next policy meeting is November 25 and no change is expected then. Given the hawkish guidance, the market is pricing in steady rates over the next 12 months, with some odds of a hike over the next six months.

ASIA

Japan Prime Minister Ishiba said he is not considering any changes in the sales tax. Seeking to solidify public support ahead of the October 27 election, he said “I’m not considering reducing the consumption tax. For the time being, I’m not considering raising it, either.” This is no surprise as policymakers are confronting a slowing economy. Tighter fiscal policy on top of tighter monetary policy would undoubtedly lead to a recession.

RBNZ Deputy Governor Hawkesby warned more easing was in the pipeline. Hawkesby said the Official Cash Rate, currently at 4.75%, “is headed more toward neutral.” However, he added that the pace of easing “is really around how things evolve from here” The RBNZ estimates the nominal neutral policy rate range between 2-4%. His comments come a day ahead of New Zealand’s Q3 CPI report, with headline expected at 2.2% y/y vs. 3.3% in Q2. The RBNZ has 2.3% y/y penciled in. Inflation is converging towards the middle of the RBNZ 1%-3% target band, leaving ample room for the RBNZ to continue easing, which would further weigh on NZD.

Caixin reported that China may raise CNY6 trln (5% of GDP) from ultra-long special government bonds over three years. The funds would reportedly be used to provide debt relief for local governments by allowing them to refinance off-balance sheet obligations. For reference, China’s 2008 fiscal bazooka which prevented a recession totaled CNY4 trln (12.5% of GDP). Mainland stocks fell and the yuan weakened as markets reacted to the lack of details on the part of policymakers. We continue to believe that China is avoiding the structural reforms needed to address the deflationary debt overhang.

COMMODITIES

Crude oil future prices are down 5% as the likelihood of a full-blown war between Iran and Israel abated. The Washington Post reported that Israeli Prime Minister Netanyahu has told the Biden administration he is willing to strike military rather than oil or nuclear facilities in Iran. Elsewhere, the IEA said that “Heightened oil supply security concerns are set against a backdrop of a global market that - as we have been highlighting for some time - looks adequately supplied. For now, supply keeps flowing, and in the absence of a major disruption, the market is faced with a sizable surplus in the new year.” For Brent, a break below the $73.45 level would set up a test of the September cycle low near $68.70.

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