The majors were all up last week, taking advantage of the dollar’s swoon Friday to claw back some recent losses. The dollar bloc outperformed while JPY, CHF, and GBP underperformed. We do not expect the BOJ intervention to change the dollar’s upward trajectory. However, with no major U.S. data reports nor Fed speakers this week, we may see a period of consolidation ahead of the November 1-2 FOMC meeting. This may allow the foreign currencies to build further on their gains near-term but we believe the fundamental backdrop for the dollar remains positive.
U.S. yields continue to rise ahead of next week’s FOMC meeting. The 2-year yield traded at a new cycle high near 4.63% Friday before reversing lower to end the week near 4.47%, while the 10-year yield traded at a new cycle high near 4.34% Friday before reversing lower to end the week near 4.22%. There was a lot of noise across all markets Friday, due in large part to the Bank of Japan’s intervention to support the yen. Looking beyond this noise, we believe the underlying trends remain in place: stronger dollar, higher U.S. yields, and lower U.S. equities.
Fed tightening expectations remain heightened. WIRP suggests a 75 bp hike next week is fully priced in and a similar 75 bp hike December 14 is about 50% priced in. What the Fed does in December will depend largely on how the data come in; between those two meetings, we will get two sets of jobs, inflation, and retail sales data. Of note, the swaps market is still pricing in a peak policy rate near 5.0%, though it briefly crept above this level last week. Some Fed officials are starting to hint at a slower pace of tightening but we’re not there yet and so would fade this move lower in U.S. yields. Due to the media embargo, there are no Fed speakers until Chair Powell’s press conference November2.
September core PCE Friday will be this week’s highlight. Consensus sees 5.2% y/y vs. 4.9% in August. If so, it would be the second straight month of acceleration to the highest since March. Shelter is likely to post another big rise, similar to what we saw in the September CPI data. Of note, shelter makes up around 16% of the PCE basket vs. nearly 33% of the CPI basket. In September, the shelter component in CPI rose 0.7% m/m and 6.6% y/y, with the y/y rate the highest since August 1982. We believe another big rise in core PCE this week would shatter the market’s recent complacency in a big way. Personal income and spending will be reported at the same time and both are expected at 0.4% m/m.
September Chicago Fed National Activity Index will be reported Monday. It is expected at -0.10 vs. 0.00 in August. If so, the 3-month moving average would rise to 0.06 vs. 0.01 in August. A zero reading means the economy is growing at around trend. The resilience in the economy is noteworthy and suggests the Fed still has a lot more work to do in getting the desired sub-trend growth. Recall that when that 3-month average moves below -0.7, that signals imminent recession and we are still well above that threshold. Taken along with the still-positively sloped 3-month to 10-year curve, we don’t expect a recession over the next 12 months. Further out than that is to be determined.
We get our first look at Q3 GDP Thursday. Consensus sees 2.3% SAAR vs. -0.6% in Q2. Of note, the Atlanta Fed’s GDPNow model is currently tracking Q3 growth at 2.9% SAAR, up from 2.8% previously. The next and final model update will be seen Wednesday. It’s worth reminding our faithful readers of the FOMC minutes in which the Fed downgraded its estimates of potential GDP, which means that the economy has been growing further above potential than previously thought. This would help explain the persistent and broad-based price pressures seen in recent months and is confirmed by recent trends in the Chicago Fed NAI.
Regional Fed manufacturing surveys will continue rolling out. Richmond Fed reports Tuesday and is expected at -5 vs. 0 in September. Kansas City Fed reports Thursday and is expected at -2 vs. 1 in September. So far, Empire has come in at -9.1 vs. -1.5 in September and Philly has come in at -8.7 vs. -9.9 in September. S&P Global reports preliminary October PMI readings Monday. Manufacturing is expected at 51.0 vs. 52.0 in September, services is expected at 49.5 vs. 49.3 in September, and the composite is expected at 49.3 vs. 49.5 in September. However, it’s worth noting that the ISM readings have been running higher than S&P Global and appear to be more closely reflecting the resilience of the U.S. economy.
Housing data this week is expected to show continued weakness. August FHFA and S&P CoreLogic house price indices will be reported Monday, with both expected to post another m/m drop. September new home sales will be reported Wednesday and are expected at -15.3% m/m vs. 28.8% in August. Pending home sales will be reported Friday and are expected at -5.0% m/m vs. -2.0% in August. Of note, the supply of new and existing homes for sale have risen dramatically in recent months due to the surge in mortgage rates. While this has not yet translated into lower shelter prices in CPI and PCE, it is only a matter of time. During the Great Financial Crisis, CPI shelter peaked at 4.3% y./y in January 2007 but didn’t bottom at -0.7% y/y until mis-2010.
Other minor data should show continued resilience in the economy. October Conference Board consumer confidence will be reported Tuesday and is expected at 105.3 vs. 108.0 in September. September advance goods trade and wholesale and retail inventories will be reported Wednesday. Weekly jobless claims will be reported Thursday. Final October University of Michigan consumer sentiment will be reported Friday.
Bank of Canada meets Wednesday and is expected to hike rates 50 bp to 3.75%. However, nearly half of the 25 analysts polled by Bloomberg look for a larger 75 bp move. WIRP suggests 75 bp is fully priced in and 10% odds of a 100 bp move. At the last meeting September 7, the bank hiked rates 75 bp to 3.25% and warned that “Given the outlook for inflation, governing council still judges that the policy interest rate will need to rise further.” It dropped the reference to front-loading the rate hikes and added “As the effects of tighter monetary policy work through the economy, we will be assessing how much higher interest rates need to go to return inflation to target.” Some took that as a pivot but since then, the data have come in firm and so the bank should continue to hike aggressively. The swaps market is pricing in 125 bp of tightening over the next 6 months that would see the policy rate peak near 4.50%.
European Central Bank meets Thursday and is expected to hike rates 75 bp. Looking ahead, another 75 bp hike December 15 is less than 50% priced in, while a 50 bp hike February 2 is about 50% priced in. After that, two more 25 bp hikes are seen over the subsequent 6 months. Similarly, the swaps market is pricing in a peak deposit rate near 3.0%. At the last meeting September 8, the bank hiked rates 75 bp and said that it expects to hike rates further over the next several meetings. President Lagarde said 75 bp was not the norm but that the large deviation of inflation from target justifies front-loading rate hikes. When asked about how far the ECB is likely to tighten, she said she did not know what the terminal rate was but did say that current rates were “far away” from the level that will return inflation to target. Lastly, she said the bank would likely hike at more than two more meetings (including September) but at fewer than five more. That leaves two, three, and four. Updated macro forecasts won’t be released until the December 15 meeting, when 2025 will be added to the forecast horizon. However, this week’s data (see below) will likely point to upward revisions in the inflation forecasts and downward revisions in the growth forecasts.
The major eurozone countries report October CPI readings. Germany, France, Italy, and Spain all report Friday. EU Harmonized inflation is expected to remain steady at 10.9% y/y in Germany, pick up two ticks to 6.4% y/y in France, pick up three ticks to 9.7% y/y in Italy, and fall a full percentage point to 8.0% y/y in Spain. Headline eurozone CPI data will be reported next Monday and there are not yet Bloomberg consensus readings. However, it’s clear that that the ECB will be under pressure to deliver further tightening despite slowing growth (see below).
The major eurozone countries also report Q3 GDP data. Germany, France, and Spain all report Friday. Growth in y/y terms is expected to slow to 0.7% vs. 1.8% in Q2 in Germany, 1.0% vs 4.2% in Q2 in France, and 3.9% vs. 6.8% in Spain. Italy and headline eurozone GDP data will be reported next Monday. the slowing trend is clear but here too, there are not yet Bloomberg consensus readings.
Eurozone reports other key data. Preliminary October PMI readings will be reported Monday. Headline manufacturing is expected at 47.9 vs. 48.4 in September, services is expected at 48.2 vs. 48.8 in September, and the composite is expected at 47.6 vs. 48.1 in September. If so, the composite reading would be the lowest since November 2020. Looking at the country breakdown, the German composite is expected at 45.5 vs. 45.7 in September and the French composite is expected at 50.2 vs. 51.2 in September. Italy and Spain will report when final PMI readings come out in early November. September M3 data will be reported Wednesday and is expected at 6.0% y/y vs. 6.1% in August.
Some key sentiment indicators will be reported by eurozone countries. October German IFO business climate survey will be reported Tuesday. Headline is expected at 83.5 vs. 84.3 in September, driven by drops in both current assessment and expectations. October French consumer confidence will be reported Wednesday and is expected to drop to points to 77. November German GfK consumer confidence will be reported Thursday and is expected at -42.0 vs. -42.5 in October. Italy also reports October consumer and manufacturing confidence Thursday, with both expected to fall by more than a point each to 93.5 and 100.0, respectively.
Over the weekend, Giorgia Meloni was sworn in as Prime Minister of Italy. Her Finance Minister is Giancarlo Giorgetti, former Development Minister in Draghi’s government. Giorgetti is more of a politician than an academic or an economist. As such, the markets will surely test him as he pushes through Meloni’s more controversial measures. As the ECB continues to hike rates aggressively, w expect fragmentation risks to rise in the coming weeks as the always difficult budget process gets under way. Italy’s 10-year spread to Germany has narrowed to 233 bp from over 250 bp in early October.
The Tories will select their new leader this week. Under the new rules, each candidate must have the support of 100 Tory MPs, effectively limiting the field to three. As of this writing , Rishi Sunak is the only one to meet this criteria so far with 120. Penny Mordaunt reportedly has the support of 22 but these numbers will likely shift significantly after Boris Johnson declared he was not in the running despite having the support of 51 MPs. The final two contenders will be announced Monday ahead of an indicative vote by all Tory MPs. If the runner-up fails to drop out, then grassroots Tory members will hold a deciding vote and the winner will be announced Friday. We believe former Chancellor Sunak would be the market favorite, though we must stress that whoever becomes the next PM inherits a terrible economic backdrop. The reversal of the Kwarteng/Truss simply brings the U.K. back to where it was on September 22, the day before the mini-budget was announced.
Otherwise, the U.K. has a quiet week. Preliminary October PMI readings will be reported Monday. Manufacturing is expected at 48.0 vs. 48.4 in September, services is expected at 49.0 vs. 50.0 in September, and the composite is expected at 48.0 vs. 49.1 in September. If so, the composite reading would be the lowest since January 2021. CBI reports its October surveys. Industrial trends will be reported Tuesday, with total orders expected at -12 vs. -2 in September. Distributive trade will be reported Thursday, with retailing reported sales expected at -15 vs. -20 in September.
Market expectations for BOE tightening have eased this month. WIRP suggests a 100 bp hike is nearly 65% priced in vs. a 150 bp hike that fully priced in late September, while the swaps market is pricing in a peak policy rate near 5.5% vs. the cycle high near 6.25% in late September. If Chancellor Hunt sticks with this pro-cyclical fiscal tightening, we believe the BOE will not have to tighten as much as was previously feared. That said, the economy is headed into recession regardless but at least the fiscal trajectory has improved under Hunt.
Markets are still digesting the Bank of Japan’s FX intervention Friday. Of note, USD/JPY dropped nearly 4% intraday the last time the bank intervened September 22. Subsequently, the pair rose and never traded again that that intraday low near 140.35. On Friday, the pair fell a nearly identical 4% but we will have to wait to see if and when it will trade at that intraday low near 146.25 again. Last time, the BOJ spent nearly $20 bln but we have yet to see any estimates yet on how much it may have spent this time. Foreign reserves fell near $51 bln to $1.125 trln in September, though some of that was due to valuation effects from the strong dollar. Simply put, Japan does not have an endless supply of dollars to intervene with and so will likely continue to picks its battles sparingly as USD/JPY eventually moves higher.
The two-day Bank of Japan meeting ends Friday. Another dovish hold is expected, similar to the last meeting September 21-22. Then, the bank downgraded its assessment of the global economy and maintained its assessment of the Japanese economy, though it warned that uncertainties remain “extremely high.” Governor Kuroda remained dovish, stressing that “We won’t raise rates for some time. We have thoroughly debated what’s the best monetary policy while considering what will happen from here, and concluded that we will continue with monetary easing.” Updated macro forecasts will be released at this week’s meeting and are likely to contain modest upward revisions to the inflation forecasts that will suggest no need to tighten soon. We expect the FY23 and FY24 inflation forecasts to continue showing a return to below target. We maintain our view that policy will be left unchanged through the end of Kuroda’s term in April, with his successor tasked with eventually engineering an exit from its current ultra-loose policy stance.
October Tokyo CPI will also be reported Friday. Headline is expected at 3.3% y/y vs. 2.8% in September, while core (ex-fresh food) is expected at 3.1% y/y vs. 2.8% in September. If so, core would be the highest since August 1991 and would signal upward pressure on national CPI. Last week, national core came in at 3.0% y/y, the highest since September 2014. In a sign that price pressures are moving beyond just energy, Tokyo core ex-energy is expected at 2.0% y/y vs. 1.7% in September.
Japan also reports some key data. Preliminary October PMI readings will be reported Monday. September department store sales will be reported Tuesday. September labor market data will be reported Friday. The unemployment rate is expected to remain steady at 2.5% while the job-to-applicant ratio is expected to rise a tick to 1.33. BOJ officials have said that they want to see greater wage pressures before tightening policy. Yet despite the tight labor market, real wages continue to decline y/y.
Australia reports key inflation data. September and Q3 CPI will be reported Wednesday. The monthly series is new and is expected at 7.1% y/y, while Q3 is expected at 7.0% y/y vs. 6.1% in Q2. If so, headline would be the highest since Q2 1990 and further above the 2-3% target range. Q3 trimmed mean is expected at 5.5% y/y vs. 4.9% in Q2, while Q3 PPI will be reported Friday. At the last meeting October 4, the bank hiked rates 25 bp to 2.60% vs. 50 bp expected. Governor Lowe stated that “The cash rate has been increased substantially in a short period of time. Reflecting this, the Board decided to increase the cash rate by 25 bp this month as it assesses the outlook for inflation and economic growth in Australia.” While the RBA said it expects to hike rates further, it’s clear that the RBA is slowing the pace to see how past tightening impacts the economy. WIRP suggests a 25 bp hike November 1 is nearly priced in, while the swaps market sees the policy rate peaking near 4.50%. Updated macro forecasts will released at that November meeting. Preliminary October PMI readings will be reported Monday.