The majors were mixed last week as early dollar weakness was followed by a sharp rebound in the second half. NOK, CAD, and NZD outperformed while SEK, GBP, and CHF underperformed. This week’s U.S. data will be a key part of the Fed rate puzzle but we have not yet seen the full impact of past tightening on the economic data yet. Some analysts are trying to pick a top for the dollar but we do not think that is possible until we have seen peak Fed tightening as well as peak U.S. recession risks. We think that is a 2023 story and so we remain dollar bulls.
U.S. yields continue to recover. The 2-year yield traded as high as 4.34% Friday after trading as low as 3.99% earlier in the week and is likely to break above the September 26 cycle high near 4.35%. Similarly, the 10-year yield traded as high as 3.91% Friday after trading as low as 3.56% earlier in the week and the break above 3.84% sets up a test of the September 28 cycle high near 4.02%. Of note, the real 10-year yield has recovered to 1.61% and is nearing a test of the September 30 cycle high near 1.67%. We believe this generalized rise in U.S. yields will continue and lend further support to the dollar.
The firm November jobs report justifies continued hawkishness from the Fed. The Fed is clearly hiking by 75 bp November 2. What happens December 14 will be data-dependent. Between the November 2 and December 14 decisions, the Fed will get two full sets of jobs, CPI, PPI, and retail sales data. Yes, a lot can happen to the data in that span and we think that is why markets are still pricing in only 50 bp in December. If (and this is a very big if) the data remain firm, the odds of a 75 bp then rise significantly. We say this because the recent data suggest solid momentum in the economy as we move into Q4.
This is a huge week for U.S. data. After Friday’s jobs data, markets will turn their attention to some major releases this week that could help cement the Fed’s likely rate path. As things stand, we believe a 75 bp hike November 2 is a done deal and a follow-up 50 bp hike December 14 is extremely likely. However, depending on how the data come in between now and then, a larger 75 bp hike in December remains within the realm of possibility. We believe many Fed officials look to continue hiking in 2023, with the February 1 and March 22 decisions very much live.
September inflation data will be in focus. PPI will be reported Wednesday. Headline is expected at 8.4% y/y vs. 8.7% in August, while core is expected to remain steady at 7.3% y/y. CPI will be reported Thursday. Headline is expected at 8.1% y/y vs. 8.3% in August, while core is expected at 6.5% y/y vs. 6.3% in August. Recent Fed commentary has focused on the trajectory of core inflation, which we presume means both core CPI and core PCE. Both have been accelerating and if that trend continues, the Fed is likely to remain hawkish regardless of the energy-related fall in the headline readings.
September retail sales data Friday will also be very important. Headline is expected at 0.2% m/m vs. 0.3% in August, while sales e-autos are expected at -0.1% m/m vs. -0.3% in August. The so-called control group used for GDP calculations is expected at 0.2% m/m vs. flat in August. Despite falling real incomes, consumption has held up relatively well so far. Indeed, the Atlanta Fed’s GDPNow model is currently tracking Q3 growth at 2.9% SAAR, up from 2.7% previously. This is the highest it’s been and was tracking as low as 0.2% SAAR on September 21. Clearly, the recent streak of strong data has improved the overall outlook for Q3. The next model update comes this Friday. Of note, the advance read for Q3 GDP comes October 27 and current Bloomberg consensus stands near 1.5% SAAR.
FOMC minutes Wednesday will be of interest. At the September 20-21 meeting, the Fed hiked rates 75 bp and delivered a very hawkish message. Chair Powell drove home this hawkish message in his press conference when he stressed that the Fed is looking for “compelling” evidence that inflation is easing and warned that history cautions against premature rate cuts. Powell noted that despite the slowdown in growth, the labor market remains “extremely tight” and out of balance. Lastly, Powell promised that the Fed will keep at it until it feels the job is done, and warned that this may lead to sustained below-trend growth and very likely softening in the labor market. Powell said there is a possibility of a pause but not at current levels, noting that “We’re at the very lowest level of what is restrictive.” The updated Dot Plots saw the median Fed Funds rate move up to 4.4% in 2022 and 4.6% in 2023. Looking further ahead, the Dots show 3.9% in 2024 and 2.9% in 2025, suggesting no significant easing until well into 2024. Fed speakers this week include Evans and Brainard Monday followed by Mester Tuesday. Kashkari, Barr, and Bowman speak Wednesday, followed by George and Cook Friday. Bullard speaks Saturday.
Other minor data should show continued resilience in the U.S. economy. Weekly jobless claims will be reported Thursday. September import/export prices, August business inventories, and preliminary October University of Michigan consumer sentiment will all be reported Friday. Headline sentiment is expected at 59.0 vs. 58.6 in September. Gasoline prices have been rising steadily from the recent low near $3.674 per gallon September 19 to stand near $3.91 currently, the highest since August 18. This argues for downside risks to the sentiment readings going forward.
Canada reports only minor data this week. August manufacturing and wholesale trade sales and existing home sales will all be reported Friday. After the firm September jobs reports saw unemployment unexpectedly falling to 5.2%, Bank of Canada tightening expectations remain elevated. WIRP suggests a 50 bp hike October 26 is now fully priced in vs. less than 65% odds earlier this week. Indeed, WIRP suggests a 50 bp hike October 26 is price d in along with nearly 30% odds of a larger 75 bp move. Looking ahead, the swaps market is pricing in a terminal rate near 4.25% over the next 6 months vs. 4.0% at the start of last week.
Eurozone has a quiet week. Italy reports August IP Tuesday and is expected flat m/m vs. 0.4% in July. Eurozone IP will be reported Wednesday and is expected at 0.6% m/m vs. -2.3% in July. Lastly, eurozone August trade data will be reported Friday and a deficit of -EUR45.0 bln is expected vs. -EUR40.3 bln in July. Ongoing deterioration in the external accounts is another headwind for the euro. ECB tightening expectations remain elevated. A 75 bp hike by the ECB October 27 is nearly priced in while the swaps market is pricing in 250 bp of tightening over the next 12 months that would see the deposit rate peak near 3.25%.
U.K. Prime Minister Truss will meet with Tory MPs Wednesday. Chancellor Kwarteng was originally scheduled to hold a regular meeting with the so-called 1922 Committee but Truss is clearly working on damage control with her own party as Parliament reconvenes from recess. Her meeting comes amidst reports that more Tory MPs are submitting letters of no confidence and rising speculation that junior ministers will resign within weeks. Senior ministers made the weekend media rounds, appearing on TV and writing op-eds calling for Tory unity. Only time will tell if this works, and much will depend on public opinion.
The Bank of England’s emergency bond-buying is set to end Friday. Of note, Deputy Governor Ramsden said that the proposed fiscal plan is “likely to be material for the economic outlook over the next three years.” He noted that the September 22 decision to hike rates 50 bp took into account government plans to cap energy prices but not the tax cuts. That implies that the November 3 decision and the updated macro forecasts will take full account of how the fiscal package will impact the outlook for inflation and growth. Ramsden stressed that “The central question for all nine of us on the MPC is how forceful do we need to be, to ensure inflation does return sustainably to the 2% target in the medium term.” Of note, market expectations for BOE tightening have eased in recent days. WIRP suggests a 125 bp hike is about 70% priced in vs. 150 bp fully priced in late September, while the swaps market is pricing in a peak policy rate between 5.5-5.75% vs. the cycle high near 6.25% in late September.
The monthly U.K. data dump begins this week. Labor market data will be reported Tuesday. Average earnings for the three months through August are expected at 5.9% y/y vs. 5.5% previously, while the unemployment rate is expected to remain steady at 3.6%. August GDP, construction output, IP, services, and trade will be reported Wednesday. GDP is expected flat m/m vs. 0.2% in July, construction is expected at 0.5% m/m vs. -0.8% in July, IP is expected at -0.1% m/m vs. -0.3% in July, and services index is expected flat m/m vs. 0.4% in July. Lastly, the trade deficit is expected at -GBP8.7 bln vs. -GBP7.8 bln in July.
Norway reports September CPI Monday. Headline is expected at 6.2% y/y vs. 6.5% in August, while underlying is expected at 5.0% y/y vs. 4.7% in August. If so, this would be the second straight deceleration for headline from the 6.8% peak in July but would remain well above the 2% target. At the last meeting September 22, Norges Bank hiked rates 50 bp to 2.25% and said it would probably hike rates again at the next meeting November 3. The bank also noted “Monetary policy is starting to have a tightening effect on the Norwegian economy. This may suggest a more gradual approach to policy rate setting ahead.” Of note, the expected rate path saw the policy rate peaking near 3.0% in Q3 23. This is more hawkish than the swaps market, which is pricing in 50 bp of tightening over the next 6 months that would see the policy rate peak near 2.75%. What happens November 3 will depend in large part on how the CPI data come in.
Sweden reports September CPI Thursday. Headline is expected at 10.5% y/y vs. 9.8% in August, while CPIF is expected at 9.3% y/y vs. 9.0% in August. If so, CPIF would be the highest since June 1991 and further above the 2% target. At the last meeting September 20, the Riksbank hiked rates 100 bp to 1.75% vs. 75 bp expected and noted 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 last month was decidedly dovish. The Riksbank saw the policy rate at 2.5% one year ahead; at its last meeting June 30, the bank expected the policy rate to be 2.0% one year ahead. We expect a 75 bp hike to 2.5% as well as a more hawkish expected rate path at the November 24 meeting that would move the Riksbank closer to the market. The swaps market is pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 3.50%.
Japan reports some key data. August core machine orders and September machine tool orders will both be reported Wednesday. Core machine orders are expected at -3.0% m/m vs. 5.3% in July. If so, the y/y rate would come in at 12.1% y/y vs. 12.1% in July. The economy is recovering but headwinds are growing, but domestically and globally.
September PPI will be reported Thursday. It is expected at 8.8% y/y vs. 9.0% in August. If so, it would continue to fall from the 9.8% peak in April and would offer hope that CPI inflation will start to ease soon. National September CPI data won’t be reported until October 21 but the Tokyo data already reported points to downside risks for headline and upside risks for core. That said, recent data support our view that the Bank of Japan is on hold for now. Next policy meeting is October 27-28 and no change is expected.
August current account data will be reported Tuesday. The adjusted balance is expected at -JPY472 bln vs. -JPY629 bln in July. If so, it would be the second straight monthly deficit as the external accounts continue to worsen due to higher energy prices and weaker exports. However, the investment flows will be of most interest. July data showed that Japan investors were net sellers of U.S. bonds for the ninth straight month (-JPY1.04 trln). Japan investors turned net sellers (-JPY290 bln) of Australian bonds again and Canadian bonds (-JPY308 bln) for the sixth straight month. Lastly, they turned small net buyers of Italian bonds (JPY29 bln).