Ebony and Ivory
- US macro backdrop argues for a shallow Fed easing cycle. In contrast, ECB signaled more cuts are in the pipeline.
- UK economy unexpectedly contracts in October. BOE is still anticipated to keep rates on hold next week.
- Japan’s Q4 Tankan business sentiment survey does not shift the dial on BOJ rate expectations.
USD rally gained traction and Treasury yields edged higher. We are sticking to our long-held bullish USD view in part because the US macro backdrop argues for a shallow Fed easing cycle.
The US November PPI data raises the possibility that progress on inflation may be stalling above the Fed’s 2% target. Core PPI printed at 3.4% y/y (consensus: 3.2%) for a second consecutive month. Also, PPI services ex-trade, transportation, and warehousing - which feeds into the core PCE calculations – remained high at 4.6% y/y, same as in October.
Moreover, strong US household balance sheet should continue to fuel consumption spending activity. Household net worth increased by roughly $4.8 trillion in Q3 driven by higher corporate equity value after rising $2.8 trillion in Q2. The bigger picture shows household’s net worth-to-disposable personal income ratio rose to 778% of GDP in Q3 vs. 761% of GDP in Q1 to be just under its all-time high at 833% of GDP in Q1 2022. US November import and export prices are due today (1:30pm London).
GBP came under broad downside pressure after the UK economy unexpectedly contracts in October. Real GDP fell -0.1% m/m (consensus: +0.1%) following a fall of -0.1% m/m in September. The details were soft but likely affected by the uncertainty around the Autumn Budget. Services output showed no growth, production output fell -0.6% m/m and construction output dropped -0.4% m/m. The Bank of England is still projected to keep the policy rate unchanged at 4.75% next week because of stubbornly high UK services inflation. The Bank of England’s (BOE) quarterly inflation attitudes survey for November is up next (9:30am London).
EUR/USD is drifting lower following yesterday’s dovish ECB cut. The ECB reduced the policy rate 25bps to 3.00% as was widely expected. However, the ECB signaled more easing is in the pipeline. The ECB tweaked lower its macro projections, and more importantly scrapped reference that it “will keep policy rates sufficiently restrictive for as long as necessary.” The implication is the ECB paved the way to bring down the policy rate within or below its neutral range - estimated to be between 1.75% and 2.50%. Markets price-in the ECB policy rate to bottom around 1.50% over the next twelve months. Bottom line: monetary policy dynamic between the ECB and Fed supports the downtrend in EUR/USD.
ECB President Christine Lagarde’s comments were mixed. Lagarde acknowledged there were some discussions around the proposal for a 50bps cut. However, she also emphasized the need to be “very cautious” when you still have 4.2% domestic inflation.
French President Emmanuel Macron is expected to name a new prime minister today. Regardless, the deeply divided parliament will make it hard for any new government to implement major fiscal changes. Importantly, the political drama faces additional twists and turns because new parliamentary elections cannot be held before June 2025 and Macron pledged to stay in place until his term end in May 2027.
USD/JPY edged up. Japan’s Q4 Tankan business sentiment survey is still indicative of a continued modest recovery in real GDP growth. Nevertheless, the data does not shift the dial on Bank of Japan (BOJ) rate expectations because inflation expectations remain contained. Large manufacturing and non-manufacturing firms expect inflation to be at 2% or below over the next one, three and five years. Markets continue to place low odds (17%) the BOJ resumes normalizing rates next week.
Peru’s central bank left the policy rate steady at 5.00% as forecast by a large majority of analysts. The bank reiterated that “year-on-year inflation and core inflation are expected to remain within the target range [1-3%] over the forecast horizon”, suggesting the bar for additional rate cuts is high.