• Fed officials are sounding more cautious; this cautiousness was reflected in FOMC minutes; September CPI will be the highlight; House Republican chose Steve Scalise to be the next Speaker; Banco de Mexico releases its minutes
  
• ECB publishes the account of its September meeting; Italy is likely to come under greater scrutiny; monthly U.K. data dump was mixed; BOE dove Dhingra warned that headwinds are still growing
  
• BOJ board member Noguchi spoke about YCC; Japan reported soft August core machine orders; China’s sovereign wealth fund bought shares of the largest commercial banks

The dollar is treading water ahead of CPI data. DXY is trading lower near 105.66 and has retraced about 38% of its August-October rally. Clean break below 105.663 would set up a test of the 50% retracement objective near 105.142. The euro is trading flat near $1.0620, while sterling is trading lower near $1.23 after soft data in August (see below). USD/JPY is trading lower near 149.10. We believe this current dollar weakness is corrective in nature. Looking beyond the current noise related to safe haven flows and dovish Fed comments, 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 and last Friday’s jobs data confirm that the U.S. economy is still running hot and needs further tightening. This drop in long date yields, if sustained, would deflate the Fed doves’ assertion that the market is doing the heavy lifting (see below).

AMERICAS

Fed officials are sounding more cautious. Even the hawks. Collins said Fed policymakers “are likely close to, and possibly at, the peak of this tightening cycle” but added that “further tightening could be warranted depending on incoming information.” Waller said “The real side of the economy seems to be doing well. The nominal side is going in the direction we want. So we’re in this position where we kind of watch and see what happens on rates.” He added that “Financial markets are tightening up and they are going to do some of the work for us.” Collins and Waller are in the hawkish camp and so their comments are noteworthy. Elsewhere, leading dove Bostic said “Today, I don’t think we need to do anything more in terms of interest rates.” Logan, Bostic, and Collins speak today.

This cautiousness was reflected in FOMC minutes. The minutes show that "A majority of participants judged that one more increase in the target federal-funds rate at a future meeting would likely be appropriate, while some judged it likely that no further increases would be warranted." Some officials said the Fed’s focus "should shift from how high to raise the policy rate to how long to hold the policy rate at restrictive levels." Lastly, "Participants generally judged that, with the stance of monetary policy in restrictive territory, risks to the achievement of the committee's goals had become more two-sided." While the decision was seen as a hawkish hold cut to the unexpected shift in the Dot Plots, the minutes suggest a much more balanced view was taken at that meeting.

That said, Fed tightening expectations remain too low. If those expectations fell because higher US yields would do the heavy lifting, shouldn't those expectations rise now that yields have fallen sharply? Yet they haven't as WIRP suggests odds of a hike November 1 still remain near 10% and rise to only 30% for December 13. The market and the Fed can't have it both ways and we think the Fed doves will end up eating their words. Once again, the market is very wrong about the Fed, as it's been this whole cycle. The first Fed cut has been moved forward to June from July previously, which is also wrong.

September CPI will be the highlight. Headline is expected to fall a tick to 3.6% y/y, while core is expected to fall two ticks to 4.1% y/y. The Cleveland Fed Nowcast model suggests headline at 3.69% and core at 4.17%, which is a little north of consensus. For October, the model suggests headline at 3.41% and core at 4.19%. PPI ran hot yesterday. Headline came in at 2.2% y/y vs. 1.6% expected and a revised 2.0% (was 1.6%) in August, while core came in at 2.7% y/y vs. 2.3% expected and a revised 2.5% (was 2.2%) in August. We get the sense that firms will have quite a bit of pricing power and so the pass-through to consumers is likely to be quite quick. We’ll know more after the CPI report but we see upside risks today.

Weekly jobless claims and September budget statement will be reported. Initial claims are expected at 210k vs. 207k last week, while continuing claims are expected at 1.676 mln vs. 1.664 mln last week. By virtually every measure, the labor market remains tight.

House Republican chose Steve Scalise to be the next Speaker. The vote within his party was 113-99 but the House refrained from a floor vote yesterday because it’s not clear whether Scalise has the 217 votes needed from the entire chamber. His rival Jim Jordan has expressed support for Scalise but we know not all of Jordan’s supporters in the House are willing to cast a vote for Scalise, at least not yet. The longer this drama is drawn out, the greater the risks of a shutdown when the continuing resolution expires November 17. Stay tuned.

Banco de Mexico releases its minutes. At the September 28 meeting, it kept rates on hold at 11.25% and said “The inflationary outlook will be complicated and uncertain throughout the entire forecast horizon, with upward risks.” Next meeting is November 9 and no change is expected. The swaps market is pricing in steady rates at the December 14 meeting too, with 50% odds of a 25 bp cut in Q1. Unlike others in the region, Mexico (as well as Colombia) is playing it very cautiously when it comes to cutting rates. As a result, MXN and COP have held up well and outperformed within Latin America in H2 even as others in the region have weakened sharply.

EUROPE/MIDDLE EAST/AFRICA

ECB publishes the account of its September meeting. At that meeting, the bank hiked rates 25 bp but suggested that rates may have peaked. Since then, bank officials have been more explicit about saying the tightening cycle had ended. WIRP is pricing in no more ECB rate hikes but more importantly, suggests nearly 50% odds of a cut in April that becomes fully priced in for June 6, presumably due to a deep recession. This is very euro-negative, to state the obvious, and so the account of the September meeting may help confirm these dovish market expectations. Elderson, Villeroy, Holzmann, Knot, Vujcic, Vasle, and Panetta all speak today.

Italy is likely to come under greater scrutiny. ECB GC member Makhlouf noted “What’s happening in Italy is both about the market views of domestic tail risk of policy, and also a relative view of Italy against other countries. It’s absolutely something that we, the ECB, will be very focused on.” Elsewhere, Vujcic said “The spreads are widening, but not too much. If you look at the change of budget projections, it’s something that could have been expected.” Italian spreads have been widening in recent weeks, prompted not only by an ill-advised bank tax but also by concerns that Italy will suffer most from tight ECB policy. We see scope for 10-year spreads to move higher and challenge last autumn’s highs near 250 bp.

The monthly U.K. data dump was mixed. August GDP, IP, services, construction output, and trade will be reported. GDP came in as expected at 0.2% m/m vs. a revised -0.6% (was -0.5%) in July, IP came in at -0.7% m/m vs. -0.1% expected and a revised -1.1% (was -0.7%) in July, services index came in at 0.4% m/m vs. 0.3% expected and a revised -0.6% (was -0.5%) in July, and construction came in at -0.5% m/m vs. 0.0% expected and a revised -0.4% (was -0.5%) in July. The trade deficit came in at -GBP3.4 bln vs. -GBP3.7 bln expected and a revised -GBP1.4 bln (was -GBP3.45 bln) in July. The economy is still eking out positive growth (barely) but we know that it’s going to get worse before it gets better.

BOE dove Dhingra warned that headwinds are still growing. Specifically, she noted that “The economy’s already flatlined. And we think only about 20% or 25% of the impact of the interest rate hikes have been fed through to the economy.” Dhingra added that the risks of a recession were equally balanced. However, she admitted that “It’s not going to be great times ahead.” if her estimate about policy pass-through is correct, we believe those risks would be tilted much more towards recession than not. Elsewhere, BOE Chief Economist Pill said “We have done a lot over the last two years. A lot of our policy is still to come through. There is still policy transmission in the pipeline. Whether we’ve done enough or whether we have more to do, I think is becoming a more finely balanced issue. But we will do what we need to do in order to have inflation at 2% on a lasting basis.” WIRP suggests 25% odds of a hike November 2, rising to 45% December 14 and topping out near 50% February 1. The first cut is not expected until Q4 2024.

ASIA

Bank of Japan board member Noguchi spoke about Yield Curve Control. Specifically, he said “At times when inflation expectations begin to rise, we need a certain degree of added flexibility to sustain monetary easing under YCC.” He later stressed that there is no rush to adjust policy for the time being. Noguchi also noted that “In the worst case scenario, it may become impossible to maintain YCC due to speculative attacks.” Lastly, he said that higher Japan yields have been driven largely by rising U.S. yields.

BOJ liftoff expectations have been pushed out from last week. WIRP now suggests no odds October 31, 15% December 19, 50% January 23, 75% March 19, and fully priced in for April 26. Of note, September PPI came in at 2.0% y/y vs. 2.4% expected and a revised 3.3% (was 3.2%) in August. This bodes well for CPI readings in the coming months.

Japan reported soft August core machine orders. Orders came in at -7.7% y/y vs. -6.7% expected and -13.0% in July. September machine tool orders were reported earlier this week at -11.2% y/y vs. -17.6% % in August. Recent data have been soft, suggesting that H2 growth will be slower than H1. No wonder the BOJ remains cautious.

China’s sovereign wealth fund bought shares of the largest commercial banks. Purchases were spread out over four banks. This was the first time the fund increased its stakes since 2015 and committed to increasing its holdings even more over the next six months. Total purchases of $65 mln are a drop in the bucket when the equity market stands at nearly $10 trln, but the effective signal is that the government is keen to support the financial system, albeit indirectly.