The major currencies had a stellar week as the dollar came under broad-based pressure after the better than expected CPI data. CHF, JPY, and SEK outperformed while CAD, NZD, and NOK underperformed. We caution against overreacting to the data as we continue to believe the Fed is nowhere near pivoting. Risk assets were also boosted last week by some loosening of China’s Covid Zero restrictions. Here too, we caution against getting too excited as the overall policy remains in place even as most other countries have moved on. This week will be key in determining whether dollar weakness will continue or not. Will Fed officials react to the market overreaction? How will U.S. PPI and retail sales data fit into the Fed narrative? Stay tuned.
Markets are still digesting last week’s CPI report. The U.S. 2-year yield traded as low as 4.29% Thursday vs. the 4.80% cycle peak from last week. The 10-year yield traded as low as 3.81% Thursday vs. the 4.34% cycle peak from last October. The U.S. bond market was closed Friday for holiday but yields seem likely to continue probing the downside this week until the data say otherwise. Equity markets latched onto the data and never looked back. For the week, the S&P 500 was up nearly 6% while the NASDAQ was up over 8%. DXY fell over 4%.
The dollar 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 below 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 tested the August 10 high near $1.0370. The 200-day moving average near $1.0435 should provide stiff resistance. 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.
Yet the market reaction last week seems outsized relative to the actual repricing of Fed tightening expectations. WIRP now suggests a 50 bp hike remains fully priced in but there are no longer any odds (for now) of a larger 75 bp move. Before the CPI data, there were only around 25% odds of a 75 bp hike. The swaps market is now pricing in a terminal rate near 5.0%, down from the 5.25% peak early last week. Easing expectations have picked up slightly, with the Fed Funds rate now seen between 4.5-4.75% in 12 months, down from 5.0% early last week. The rate is seen between 3.5-3.75% in 24 months, down from 4.0% early last week. These are not huge adjustments in Fed expectations and so it’s hard to justify just how much equity, bond, and FX markets moved last week. Before the December 13-14 meeting, we will get one more each of the jobs report, CPI, core PCE, and retail sales data along with two more PPI reports and so Fed expectations are likely to continue adjusting.
U.S. yield curve inversion has deepened. Our favored curve is the 3-month to 10-yaer and after flirting with inversion the past couple of weeks, it has inverted deeply to the tune of -34 bp and is the most since September 2019. The 2- to 10-year curve has been inverted since July and is currently near -52 bp, just above the cycle low near -57 bp from early November. We await confirmation from the Chicago Fed National Activity Index but it seems that the U.S. economy is likely to go into recession over the next 12 months or so. Should equities really be rallying so much?
Fed speakers this week will be closely watched. After the CPI data, several Fed speakers seemed open to slowing the pace of tightening. Last week ended with higher equities, lower yields, and tighter spreads on corporate bonds. The Fed won't be happy to see this market reaction as financial conditions are back to being the loosest since late September, right after the Fed hiked rates 75 bp and set an unequivocally hawkish tone. The Fed speakers this week may take a somewhat more hawkish tone compared to those that sounded more dovish this week after the CPI data. Waller speaks Sunday. Brainard and Williams speak Monday. Harker, Cook, and Barr speak Tuesday. Williams, Barr, and Waller speak Wednesday. Bullard, Bowman, Mester, Jefferson, and Kashkari speak Thursday. Collins speaks Friday. Let’s see how they sound this week after last week’s data and market reaction.
October PPI will be reported Tuesday. Headline is expected at 8.4% vs. 8.5% in September, while core is expected to remain steady at 7.2% y/y. As we noted last week, the October CPI reading fell in large part due to a statistical quirk that led to a -4% m/m drop in health insurance costs. That sort of quirk seems unlikely in the PPI data, while the PCE basket uses a different method to calculate health insurance costs. And as the Fed has said many times, it is not looking at any one data point but at the entirety. Still, it may be hard for the PPI data to dispel the notion that the Fed is moving closer to a pivot.
October retail sales will be reported Wednesday. Headline is expected at 1.0 % m/m vs. flat in September, while sales ex-autos are expected at 0.5% vs. 0.1% in September. The so-called control group used for GDP calculations is expected at 0.3% m/m vs. 0.4% in September. Of note, the Atlanta Fed GDPNow model is currently tracking 4.0% SAAR, up from 3.6% previously. The next model update will come Wednesday after the data. Of note, University of Michigan consumer sentiment fell sharply to 54.7 in November, reversing four straight months of improvement from the 50.0 low in June. Can consumption continue to hold up? We’ll know more Wednesday.
Regional Fed manufacturing surveys for November will start rolling out. Empire survey kicks things off Tuesday and is expected at -6.0 vs. -9.1 in October. Philly Fed then reports Thursday and is expected at -6.0 vs.-8.7 in October. Kansas City Fed also reports Thursday and is expected to remain steady at -7. In between, October IP will be reported Wednesday and is expected at 0.1% m/m vs. 0.4% in September. Overall, the manufacturing sector is slowing but has held up relatively well in the face of Fed tightening.
Weekly jobless claims Thursday will be of interest. That’s because initial claims are for the BLS survey week containing the 12th of the month. They are expected at 222k vs. 225k the previous week. Continuing claims are reported with a one-week lag and so next week’s reading will be for the BLS survey week. This week, they are expected at 1.509 mln vs. 1.493 mln the previous week.
Housing data are expected to show continued weakness. November NAHB housing index will be reported Wednesday and is expected at 36 vs. 38 in October. If so, it would be the lowest since May 2020. October building permits and housing starts will be reported Thursday and are expected at -3.1% m/m and -1.9% m/m, respectively. Existing home sales will be reported Friday and are expected at -7.2% m/m vs. -1.5% in September. Other minor data will be reported. October import/export prices, September business inventories, and September TIC data will be reported Wednesday. October leading index will be reported Friday and is expected to remain steady at -0.4% m/m.
Canada highlight will be October CPI Wednesday. Headline is expected at 7.0% vs. 6.9% in September, while core common is expected at 5.9% y/y vs. 6.0% in September. If so, this would be the first acceleration in headline since the June peak of 8.1%. Bank of Canada next meets December 7 and a 25 bp hike to 4.0% is expected. WIRP suggests 30% odds of a larger 50 bp move. Last week, Governor Macklem said “We indicated that we expect interest rates do have further to go, and I think that could be another bigger-than-normal step or it could be reverting to more normal 25 bp steps, we’ll see.” The labor market remains strong and Macklem said “We need to rebalance the labor market. This will be a difficult adjustment. We want to do this in the best way possible for Canadian workers and businesses.” Of note, the swaps market is pricing in a peak policy rate near 4.25%, down from 4.75% in late October. Ahead of the CPI data, September manufacturing and wholesale trade sales and October existing home sales will be reported Tuesday. October housing starts will be reported Wednesday.
U.K. Chancellor Hunt will make his first budget statement Thursday. Reports suggest he is trying to identify over GBP50 bln in spending cuts and tax hikes in an effort to get the debt trajectory back on a sustainable path. Sources suggest Hunt is considering a hike in the windfall tax oil and gas companies to 30% from 25% currently, as well as a possible hike in the top tax rate from 45% currently and/or lowering the threshold from GDP150k currently. A potential hike in the capital gains tax is also being considered. Hunt also has to decide whether to increase pension and welfare payments in line with inflation or a smaller increase that could save GBP13 bln. Whatever the eventual package consists of, we know it will be a considerable fiscal drag coming at a time when the economy is already slipping into recession.
The U.K. data dump continues. Labor market data will be reported Tuesday. The unemployment rate is expected to remain steady at 3.5% for the three months ended in September, while average weekly earnings are expected to slow a tick to 5.9% y/y. October CPI data will be reported Wednesday. Headline is expected at 10.7% vs. 10.1% in September, core is expected at 6.4% y/y vs. 6.5% in September, and CPIH is expected at 9.3% y/y vs. 8.8% in September. November GfK consumer confidence will be reported Thursday and is expected at -46 vs. -47 in October. October retail sales will be reported Friday. Headline is expected at 0.5% m/m vs. -1.4% in September, while sales ex-auto fuel is expected at 0.6% m/m vs. -1.5% in September.
Bank of England tightening expectations are still adjusting. WIRP suggests a 50 bp hike December 15 is priced in, with 35% odds of a larger 75 bp hike, down from over 60% at the start of last week. 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%, down sharply from 6.25% right after the mini-budget in late September. There are several key BOE speakers this week. Bailey testifies before Parliament Wednesday. Pill and Tenreyro speak Thursday. Of note, Tenreyro voted for a 25 bp cut last week and so her comments should tilt dovish. Mann and Haskel speak Friday.
Eurozone has a very quiet week. September IP will be reported Monday and is expected at 0.5% m/m vs. 1.5% in August. If so, the y/y rate would improve to 3.0% vs. 2.5% in August. German November ZEW survey will be reported Tuesday. Revised eurozone Q3 GDP and employment data will also be reported Tuesday. Eurozone September construction output will be reported Thursday.
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. The ECB will update its macro forecasts at the December meeting and are likely to show similar revisions as the EU unveiled last week. 2025 will be added to the ECB’s forecast horizon then. We think there is still room for ECB tightening expectations to fall further and we stand by our call that the ECB will pivot and cut rates before the Fed does. Panetta, Centeno, Guindos, and Villeroy speak Monday. Villeroy and Elderson speak Tuesday. Villeroy, Lagarde, and Panetta speak Wednesday. Villeroy speaks again Thursday. Lagarde, Nagel, and Knot speak Friday.
Sweden reports October CPI data Tuesday. Headline is expected at 11.0% vs. 10.8% in September, while targeted CPIF is expected to pick up a tick to 9.8% y/y. If so, both would be making new cycle highs. Next Riksbank meeting is November 24 and WIRP suggests a 50 bp hike is priced in along with 25% odds of a larger 75 bp move. At the last meeting September 20, the bank delivered a hawkish surprise and hiked rates 100 bp to 1.75% vs. 75 bp expected. The bank noted then that “The risk is still large that inflation becomes entrenched, and it is extremely important that monetary policy acts to ensure that inflation falls back and stabilizes. Monetary policy now needs to act more than was anticipated in June.” However, the rest of its messaging was decidedly dovish. The Riksbank saw the policy rate at 2.5% one year from now; at its last meeting June 30, the bank expected the policy rate to be 2.0% one year ahead. Both seem woefully inadequate as inflation continues to rise. We expect a more hawkish shift at this meeting that would move the Riksbank closer to the market. The swaps market is pricing in 150 bp of tightening over the next 12 months that would see the policy rate peak near 3.25%.
Japan has a very busy week. Q3 GDP data will be reported Tuesday. Growth is expected at 1.2% SAAR vs. 3.5% in Q2 and expected at 0.3% q/q vs. 0.9% in Q2. September core machine orders will be reported Wednesday and are expected at 7.5% y/y vs. 9.7% in August. October trade data will be reported Thursday. Exports are expected at 29.4% y/y vs. 28.9% in September, while imports are expected at 50.0% y/y vs. 45.7% in September.
October national CPI data will be reported 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.
Australia highlight will be October jobs data Thursday. Consensus sees 15.0k jobs added vs. 0.9k in September, with the unemployment rate seen rising a tick to 3.6%. The latest RBA forecast sees a rather gentle rise in unemployment to 3.75% in 2023 and 4.25% in 2024, which the bank sees as a necessary evil to bring inflation back to target.
RBA tightening expectations remain subdued. WIRP suggests only 60% odds of a 25 bp hike December 6. The swaps market is pricing in 75 bp bp of tightening over the next 12 months that would see the policy rate peak near 3.65%.