Yen Surges After LDP Leadership Vote

September 27, 2024

Win Thin

The market is starting to take back some of its Fed easing bets; the Fed continues to put up a united front; U.S. data highlight will be PCE; personal income and spending will be reported at the same time; we get updated Q3 GDP estimates; Canada reports July GDP
Eurozone September CPI data is cooling quickly; the ECB is starting to acknowledge growing downside risks; ECB reported August inflation expectations; U.K. CBI reported its September distributive trades survey
Japan’s ruling LDP chose Shigeru Ishiba as its new leader; Japan reported soft September Tokyo CPI data; PBOC went ahead with the rate cuts announced earlier this week; China reported weak August industrial profits

The yen surged after the LDP vote. DXY is trading lower for the second straight day near 100.448 but the softness is all coming from the yen. The yen is outperforming after the LDP leadership vote (see below), with USD/JPY trading lower near 143.20. The euro is trading lower near $1.1165 after lower than expected CPI data from France and Spain push up odds of an ECB cut in October (see below), while sterling is trading lower near $1.3390. Market easing expectations are starting to adjust but still remain too dovish as the U.S. data remain firm. Yet we cannot stand in the way of this move and so until market pricing changes, the dollar is likely to remain vulnerable.

AMERICAS

The market is starting to take back some of its Fed easing bets. The market is still pricing in 75 bp of easing by year-end but is now pricing in 175 bp of total easing over the next 12 months vs. 200 bp at the start of this week. This is still deep recession pricing but these bets should continue to be pared back if the U.S. data come in firm. Until the market reprices Fed easing further, we think the dollar will remain vulnerable.

The Fed continues to put up a united front. Yesterday, Governor Cook pointed out “upside risks to inflation have diminished, and the downside risks to employment have increased. In response to these changing conditions, I whole heartedly supported the decision at last week's Federal Open Market Committee (FOMC) meeting to lower our policy interest rate by 1/2 percentage point.” This comes a day after Governor Kugler said she “strongly supported” the 50 bp cut. However, it’s very interesting that most Fed officials won’t comment on future policy moves. Governor Bowman speaks today and will offer a much more cautious viewpoint that reflects her dissent this month in favor of a smaller 25 bp cut.

U.S. data highlight will be PCE. Headline is expected to fall two ticks to 2.3% y/y while core is expected to pick up a tick to 2.7% y/y. Of note, the Cleveland Fed’s Nowcast model sees headline at 2.3% and core at 2.8%. Looking ahead to September, the model sees headline at 2.1% and core at 2.7%. Overall, the progress on inflation seen since April is encouraging and the FOMC still projects PCE inflation to return sustainably to 2% in 2026.

Personal income and spending will be reported at the same time. Both are expected to remain indicative of solid domestic demand activity. Personal income is expected to rise 0.4% m/m vs. 0.3% in July, personal spending is expected to increase 0.3% m/m vs. 0.5% in July, and real personal spending is expected to rise 0.1% m/m vs. 0.4% in July. Of note, the control group retail sales used for GDP calculations grew 0.3% m/m in August after rising 0.4% the previous month.

We get updated Q3 GDP estimates. The New York Fed’s Nowcast model is tracking Q3 growth at 3.0% SAAR and Q4 growth at 2.7% SAAR. Elsewhere, the Atlanta Fed’s GDPNow model is tracking Q3 growth at 2.9% SAAR. Both models will be updated today after the data. The Fed's updated macro forecasts may be a tad too optimistic but we agree with the directional message; that is, we see a soft landing and avoid recession.

Weekly jobless claims are worth discussing. That’s because continuing claims will be for the BLS survey week containing the 12th of the month and came in at 1.834 mln vs. 1.828 mln expected and a revised 1.821 mln (was 1.829 mln) last week. Initial claims came in at 218k vs. 223k expected and a revised 222k (was 219k) last week. As a result, the 4-week moving average fell to 225k vs. 228k last week and was the lowest since late May. Despite all the worries about the labor market, the data suggest it remains relatively robust. Of note, Bloomberg consensus for NFP is 140k, while its whisper number stands at 130k.

Canada reports July GDP. Statistics Canada estimates real GDP to be essentially unchanged for a second consecutive month in July, while consensus sees 0.1% m/m. Soggy economic activity, slower inflation, and growing slack in the labor market argue for a 50 bp rate cut at the next Bank of Canada meeting October 23. The swaps market pricing over 50% odds of such a cut.

EUROPE/MIDDLE EAST/AFRICA

Eurozone September CPI data is cooling quickly. France’s EU Harmonised inflation came in at 1.5% y/y vs. 1.9% expected and 2.2% in August, while Spain’s came in at 1.7% y/y vs. 1.9% expected and 2.4% in August. Spain is one of the only eurozone countries to report core inflation and it came in at 2.4% y/y vs. 2.8% expected and 2.7% in August. Germany and Italy report next Monday and the eurozone reports next Tuesday. Eurozone headline is expected to fall two ticks to 2.0% while core is expected to remain steady at 2.8% y/y but there are clear downside risks. Continued disinflation will allow the ECB to continue easing.

The ECB is starting to acknowledge growing downside risks. Yesterday, Schnabel acknowledged that the “euro-area economy is stagnating,” adding that “surveys signal slowing economy” and that there are “increasing signs of softening” in the labor market. This is a brutally honest take on the state of affairs. The battle between the hawks and the doves will continue to play out but it now appears that the doves are gaining the upper hand as market odds for an October cut have risen to nearly 80% vs. 25% at the end of last week.

ECB reported August inflation expectations. 1-year expectations came in at 2.7% and 3-year expectations came at 2.3%, both as expected and both down a tick from July. Easing inflation expectations leaves plenty of room for the ECB to keep cutting interest rates.

U.K. CBI reported its September distributive trades survey. Retailing reported sales came in at 4 vs. -18 expected and -27 in August, while total distributive reported sales came in at -8 vs. -20 in August. The CBI survey suggests consumption will remain robust after August’s bounce. BRC reports its September sales data October 7, while official retail sales data will be reported October 18.

ASIA

Japan’s ruling Liberal Democratic Party chose Shigeru Ishiba as its new leader. Ishiba effectively becomes the new Prime Minister. General elections aren’t due until 2025, but it’s possible Ishiba calls early elections to solidify his support. The yen surged on the news as investors unwound bets that Sanae Takaichi would win the leadership race. Takaichi argued earlier this week that “it’s stupid to raise rates now” and dragged JPY lower against most major currencies on expectations she would encourage the BOJ to keep policy looser for longer. We would look to fade this move down in USD/JPY, as the BOJ’s cautious policy tightening guidance should curtail the yen’s upside potential.

Indeed, Japan reported soft September Tokyo CPI data. Headline came in at 2.2% y/y vs. 2.6% in August, core (ex-fresh food) came in at 2.0% y/y vs. 2.4% in August, and core ex-energy remained steady as expected at 1.6% y/y. All three were as expected and show a significant reversal of the recent rise in inflation. It also reinforces our doubts that the BOJ will tighten more than is currently priced in, which is only 25 bp of total tightening over the next 12 months. Some analysts are calling for a December hike but we think it will be a 2025 story.

The People’s Bank of China went ahead with the rate cuts announced earlier this week. The policy-relevant 7-day reverse repurchase rate was cut 20 bp to 1.50% and banks’ reserve requirement ratios were lowered 50 bp. The PBOC also slashed the 14-day reverse repurchase rate 20 bp to 1.65%, moving it closer to the 7-day repo rate. Chinese stocks and iron ore prices continue to edge higher as the government’s recent stimulus pledge boosts market sentiment. However, the real sector impact is likely to be limited as policymakers have yet to address the huge debt overhang.

China reported weak August industrial profits. Profits came in at -17.8% y/y vs. 4.1% in July and came in at 0.5% YTD vs. 3.6% in July. This is sobering news and underscores just how difficult it will be to turn things around in China.

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