Markets Calm but Trepidation Runs High

by
Marc Chandler
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Overview: Fears that the Israel-Hamas war was going to widen this past weekend sent gold and oil sharply higher at the end of last week. A reportedly more restrained Israeli entrance into Gaza has seen gold pullback back below $2000 (~-0.6%) and December WTI soften (~-1.7%). The US dollar is mostly softer. Stronger-than-expected Australian retail sales fan the risk of a hike next week and this appears to be helping the Australian dollar lead the advancing G10 currencies. The greenback also remains below JPY150. Most emerging market currencies are off to a firm start.

Outside of Japan and Australia, Asia Pacific equity markets are mostly higher. The MSCI Asia Pacific Index fell by about 0.5% last week after dropping 2.7% the previous week. Europe's Stoxx 600 is beginning the week on a firm note, with a 0.75% gain. If sustained, it would be the most in nearly three weeks. It fell nearly 1% last week. US index futures are trading higher. The S&P 500 and NASDAQ fell by a little more than 2.5% last week. Meanwhile, ahead of tomorrow BOJ decision, the 10-year JGB yield edged up to a new high, a little above 0.88%. European yields are mostly 3-4 bp lower, though Italy's 10-year yield is off nearly seven basis points. The 10-year US Treasury yield is up almost three basis points to slightly above 4.86%. A few hours before the FOMC meeting concludes on Wednesday, Treasury will announce its Q4 funding plans, and the issue seems to be where the marginal new supply is focused bills or coupons. 

Asia Pacific

Australia's retail sales rose by 0.9% in September, well above the 0.3% median projection of Bloomberg 's survey. July and August were revised slightly higher. This is a nominal number, which means it is picking up an increase in prices. In real terms, Australia's retail sales do not appear as strong. The official estimate is due on November 3. That said, after the slightly firmer-than-expected Q3 CPI report last week, the market sees an increased chance that the Reserve Bank will hike rates again. The futures market now has a little more than a 50% chance of a hike next week, roughly double the odds seen before the inflation report. There is also a little more than a 75% chance of a hike discounted before the end of the year.

China reports its October PMI tomorrow. The median forecasts in the Bloomberg survey do not expect much change. We suspect the risk is on the upside as the formal and informal efforts by Beijing begin to find more traction. While structural challenges, like the property market, are still disrupting activity, the extent of non-market forces and relationships may not be fully appreciated. Moreover, new fiscal measures have been announced and may take some time to be implemented, but the signaling may be powerful in its own right. The National Financial Work Conference is taking place today and tomorrow, and new measures to address the property sector and local government risks are seen likely.

Japan's September employment report, retail sales, and industrial output figures will be reported tomorrow. Firm data is expected. The unemployment rate is seen slipping to 2.6% from 2.7%, retail sales may match the upwardly revised 0.2% August gain, and industrial production is expected to bounce back after declining by 0.7% in August and 1.8% in July. The focus though, is on the outcome of the BOJ meeting. Speculation that it may move could have been behind the short squeeze that lifted the yen ahead of the weekend. There are many moving parts of the extraordinary monetary policy, including the easing bias, the band of the 10-year JGB and its center point, and the negative policy rate. A poor reception to the two-year note sale (lowest bid-cover in more than a decade, but still more 3.0x) seems to reflect an appreciation that policy is changing. Also, the forecasts should be understood not simply a technocratic function but as a communication tool. Will the BOJ signal greater confidence that 2% inflation is sustainable by lifting its forecasts? 

Position-squaring appeared to knock the dollar lower ahead of the weekend after the stronger than expected Tokyo CPI strengthened speculation of a change in BOJ policy this week. After falling to about JPY149.45 before the weekend, the dollar's losses have been extended to JPY149.30 today. It has remained below JPY149.85. The 20-day moving average is close to JPY149.50, and the dollar has not settled low since late July. Nearly $1.4 bln of options struck there expire today. Tomorrow sees the expiration of nearly $1.1 bln options at JPY150.00. For a most of October, the Australian dollar has chopped back and forth between a little below $0.6300 to a little above $0.6400. It did record a marginal new low for the year last week near $0.6270 but quickly returned to its well-worn range. The Aussie is the strongest of the G10 currencies, rising almost 0.5% today to return to the pre-weekend high, around $0.6370. The Chinese yuan is flattish, trading within narrow pre-weekend range (~CNY7.3145-CNY7.3185). Note that the dollar has settled in a six-tick range in the last three sessions (CNY7.3168-CNY7.3174). The PBOC set the dollar's reference rate at CNY7.1781, while the average in projection in the Bloomberg survey was for CNY7.3169.

Europe

Below the surface, the balance of risks is changing in the eurozone, and it will be driven home by this week's highlights:  Q3 GDP and October's preliminary CPI. They will be reported tomorrow. It will not be surprising to see a dramatic slowing in CPI as last October's 1.5% gain drops out of the 12-month comparison. The question is how close the year-over-year rate approaches 3.0% (from 4.3% in September and 9.2% at the end of 2022). The core rate is expected to slow more moderately to 4.2% (from 4.5% in September and the 5.7% peak set in March). Of course, no one is declaring victory, but prices are moving in the right direction. Six German states have reported October CPI and not reported a monthly increase. The national figures will be released shortly. 

Growth is more problematic. Spain reported Q3 GDP expanded by 0.3%, slightly better than expected. That is where the good news ends. Earlier today, German reported a 0.1% contraction. This followed an upward revision Q2 GDP to 0.1% from flat. France and Italy report tomorrow. France may have stagnated, and there may be downside risks to the median forecast in Bloomberg's survey of 0.1% growth. 

The news stream from the eurozone is uninspiring, and the euro languishes in its trough as it consolidates after falling for 11 consecutive weeks into early October. After being turned back from the month's high set in the middle of last week (~$1.0695), the euro has chopped between roughly $1.0525 and $1.0605. It is trading inside the pre-weekend range (~$1.0535-$1.0595). Sterling's pattern in similar. It peaked in last Wednesday, though a little shy of the month's high (~$1.2290 vs. $1.2335) and has consolidated in a cent-range below $1.2175. So far, today's range is roughly from $1.2090 to almost $1.2140. Initial resistance is seen near $1.2155. The Bank of England meets Thursday, and while no change in policy is expected, and recent data warn of that growth forecasts may be cut.

America

The rise one-year inflation expectations in the University of Michigan's consumer confidence survey from 3.2% in September to 3.8% preliminary estimate and to 4.2% final reading was reported ahead of the weekend. It is especially important now as policymakers and investors try to understand the 100 bp jump in the US 10-year yield in the past two-and-a-half months. The University of Michigan also surveys 5-10-year inflation expectations. They rose to 3.0% from 2.8% in September. It is unchanged from the end of 2022 and up 0.1% from the end of 2021. The NY Fed's survey in September, published on October 10 (here), found a slight increase in the near-term outlook (one-year rose by 0.1% to 3.7%, and three-year expectations rose by 0.2% to 3.0%) but a small decline in the five-year expectation (-0.2% to 2.8%). There are market-based measures of inflation expectations, too. The 10-year breakeven (difference between the conventional and inflation-protected security) is near 2.40%. It was around 2.30% at the end of last year, which is also where the 200-day moving average is found. Another market-based measure of inflation expectations is the five-year five-year inflation swap (capturing the five-year inflation expectation starting in five years). It is near 2.75%, which is slightly elevated (the 200-day moving average is a little above 2.60%). The five-year-five-year inflation swap was closer to 2.50% at the end of last year.

The Canadian dollar fell to new lows for the year before the weekend. It rivaled the Swiss franc as the weakest of the G10 currencies. Exogenous factors like oil (rallied) and risk (US stocks fell) would seem to pull in opposite directions. One of the considerations may be shift in Bank of Canada expectations. The swaps market is discounting around an 85% chance of a cut by early Q3 24. A week ago, the probability was about 33%. Over the past two weeks, Canada's two-year yield has fallen a little more than 25 bp. The US dollar reached CAD1.3880 at the end of last week. There is little on the charts to prevent a run at last year's high near CAD1.3975. The note of caution from technicals is that the greenback settled above the upper Bollinger Band (~CAD1.3870). Initial support is seen near CAD1.3800. A wider-than-expected October traded deficit did not stop Mexican from reaching a seven-day high ahead of the weekend. The dollar fell to MXN18.00 to dip below the 20-day moving average (~MXN18.0950) for the first time in a month. However, the greenback recovered back above MXN18.10 in late dealing before the weekend. It has come back offered today and is near the pre-weekend lows. The dollar recovered more dramatically against the Brazilian real. The dollar initially fell to almost BRL4.93, the lowest level since September 22, and then surged to session highs near BRL5.0150. Brazil's central bank is expected to deliver a 50 bp cut in the Selic rate a few hours after the FOMC meeting concludes on Wednesday.