Risk sentiment came under severe pressure last week as the major central banks continued to tighten policy aggressively. A huge fiscal policy mistake from the U.K. didn’t help matters. The dollar surged across the board and SEK GBP, and NZD were hit the hardest while JPY and CHF outperformed. MSCI World tumbled -5% in its worst week since mid-June. With global growth also slowing significantly, the backdrop for risk assets remains challenging. We expect the dollar to continue strengthening in this environment even as Fed tightening expectations remain elevated.
AMERICAS
Markets are still digesting last week’s hawkish FOMC decision. WIRP suggests another 75 bp hike is almost fully priced in for November 2, as is a follow-up 50 bp hike December 14. Elsewhere, the swaps market is pricing in a terminal rate of 4.75%. As a result, U.S. rates continue to rise. The 2-year yield traded near 4.27% Friday, the highest since October 2007, while the 10-year yield traded near 3.82%, the highest since April 2010. The real 10-year yield traded near 1.32%, the highest since March 2010. This generalized increase in U.S. yields is likely to continue and will ultimately support the dollar. Of note, the 3-month to 10-year curve remains positively sloped near 50 bp, the steepest since July, and so we are not yet ready to call for an imminent recession in the U.S.
Many Fed officials will spread the message this week. Colling, Bostic, Logan, and Mester speak Monday. Evans, Powell, Bullard, Kashkari, and Daly speak Tuesday. Bostic, Bullard, Powell, Bowman, and Evans speak Wednesday. Bullard, Mester, and Daly speak Thursday. Brainard, Bowman, Barkin, and Williams wrap things up Friday. All are expected to hew to the hawkish stance, though Powell did note that there was a “fairly large” group on the FOMC that saw 100 bp of tightening by year-end vs. the 125 bp median. As such, there may be some modest hints of dovishness but make no mistake, this Fed is serious about getting inflation back to target.
August Chicago Fed National Activity Index will be reported Monday. It is expected at 0.23 vs. 0.27 in July. If so, the 3-month moving average should rise to 0.08 vs. -0.09 in July and would show continued resilience in the US economy. Recall that when that 3-month average moves below -0.7, that signals imminent recession and we are still well above that threshold. Negative readings indicate the economy is growing below trend and that is what the Fed wants. Still, many fear a hard landing and so we need to keep an eye on this data series as well as the U.S. yield curve. At 50 bp, the 3-month to 10-year curve is the steepest since July and above the cycle low near 21 bp from August. While this move higher is welcome, the risks of eventual inversion still remain high.
We get another look at Q2 GDP Thursday. Consensus sees no change at -0.6% SAAR. Of course, this is old news and markets are already looking ahead to Q3 and Q4. The Atlanta Fed’s GDPNow model is currently tracking Q3 growth at 0.3% SAAR, down from 0.5% previously. The next model update will be this Tuesday. Of note, Bloomberg consensus sees Q3 at 1.4% SAAR and Q4 at 1.0% SAAR.
August core PCE Friday will be important. Consensus sees it picking up a tick to 4.7% y/y and comes after it fell two ticks in July. This is why the Fed continues to stress that it will not focus on only one or two inflation readings. Rather, the Fed clearly wants to see a sustained drop in the inflation measures before it will even contemplate a pivot. Personal income and spending will be reported at the same time and are expected at 0.3% m/m and 0.2% m/m, both a ticker higher than July.
We get some key survey readings this week. Regional Fed manufacturing survey for September will wrap up. Dallas reports Monday and is expected at -10.0 vs. -12.9 in August. Richmond reports Tuesday and is expected at -11 vs. -8 in August. Chicago PMI will be reported Friday and is expected at 51.8 vs. 52.2 in August. Last week, preliminary September S&P Global PMIs came in higher than expected and moved closer to the ISM readings, which are more upbeat.
Housing data this week are expected to show continued weakness. July FHFA and S&P CoreLogic house price indices and August new home sales (-2.2% m/m expected) will be reported Tuesday. Pending home sales (-1.5% m/m expected) will be reported Wednesday. Other minor data include August durable goods orders and September Conference Board consumer confidence Tuesday. August advance goods trade data and wholesale and retail inventories will be reported Wednesday. Final September University of Michigan consumer sentiment will be reported Friday.
Weekly jobless claims Thursday will be key. Initial claims are expected at 215k vs. 213k last week, which were for the BLS survey week containing the 12th of the month. That was the lowest since late May while the four-week moving average of 217k was the lowest since early June. Continuing claims are reported with a one-week lag and so this week’s reading will be for the BLS survey week. These claims are expected at 1.383 mln vs. 1.379 mln last week, the lowest since mid-July. The recent claims data point to continued resilience in the labor market. Current consensus for September NFP is 250k vs. 315k in August but there are still many more clues to come.
EUROPE/MIDDLE EAST/AFRICA
September eurozone CPI readings will be the highlight this week. Spain and Germany report Thursday. EU Harmonized CPI for Spain is expected at 10.0% y/y vs. 10.5% in August and for Germany at 10.2% y/y vs. 8.8% in August. France, Italy, and eurozone CPI will be reported Friday. EU Harmonized CPI for France is expected to remain steady at 6.6% y/y and for Italy at 9.4% y/y vs. 9.1% in August. For the eurozone as a whole, headline inflation is expected at 9.7% y/y vs. 9.1% in August and core is expected at 4.7% y/y vs. 4.3% in August.
This should keep ECB tightening expectations heightened. WIRP suggests another 75 bp is almost full priced in for the next meeting October 27, 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%, up from 2.75% at the start of last week.
Real sector data will also be in focus. German reports September IFO business climate survey Monday. Headline is expected at 87.0 vs. 88.5 in August and reflecting similar drops in both current assessment and expectations. October GfK consumer confidence will be reported Thursday and is expected at -39.0 vs. -36.5 in September. France and Italy also reports September consumer confidence Thursday. Spain report August retail sales and France reports August consumer spending on Friday. Germany reports September unemployment Friday.
Italy is likely to become more of a market focus in the coming weeks. As of this writing, voting continues but recent polls suggest that the Brothers of Italy party will win the most seats in parliament and so its leader Giorgia Meloni will likely lead the next government. She has taken pains to assure the markets that she will continue orthodox policies. However, markets are not in a forgiving move and so any hints to the contrary should see Italy come under similar pressure to the U.K. As it is, we believe the right-wing coalition will have the same difficulties passing structural reforms as Draghi’s technocrat government did. To make matters worse, the ECB is expected to tighten policy aggressively even as Italy slips into recession. We expect further upward pressure on Italian yields in the coming weeks.
U.K. assets are likely to continue feeling the fallout from last week’s tax cut plan. We cannot think of another instance like this in recent history where the markets have given an instant and unmistakable thumbs down to a policy announcement. Indeed, it looks like even more fireworks are coming as U.K. press reports that the Truss government plans to introduce even more tax cuts in 2023. Reports suggest the measures include further cuts in income tax rates as well as tax breaks for pensioners . These are reportedly likely to be announced as part of a full budget next year.
Bank of England tightening expectations have picked up as a result of the fiscal stimulus. Is there anything the BOE can do to support the pound? They just met last week and hiked a lackluster 50 bp but would 75 or 100 bp really have made much difference? Sentiment was already poor but the tax package simply poured gasoline on the fire. We don't think any sort of emergency BOE rate hike would do much to support the currency beyond a brief knee-jerk reaction. As it is, WIRP is pricing nearly 60% odds of a 100 bp hike November 3 while the swaps market is pricing in a peak policy rate near 5.75% over the next 12 months, up from 4.5-4.75% at the start of last week. Yet this has done nothing for sterling. Market confidence, once lost, is always difficult to regain.
ASIA
Japan reports some key data this week. Preliminary September PMI readings will be reported Monday. The composite PMI slipped below 50 in August for the first time since February. The economy is slowing recovering as it reopens but domestic demand is spotty even as external demand weakens. August labor market data, IP, and retail sales will be reported Friday. Unemployment is seen falling a tick to 2.5% even as the job-to-applicant ratio is seen rising a tick to 1.30. IP is expected at 0.2% m/m vs. 0.8% in July while sales are expected at 0.4% m/m vs. 0.7% in July.
No wonder the Bank of Japan delivered another dovish hold last week. Yet it cannot have its cake and eat it too. By maintaining ultra-loose policy, the bank will only encourage further yen weakness. BOJ intervention may introduce more two-way risk in the FX market but it cannot reverse the weak yen trend. Only a pivot to a less dovish stance can do that and it’s clear the BOJ is not ready to do that yet. Indeed, we see steady policy through at least the end of Governor Kuroda’s term in April.
