Week Ahead: Will Softer US Price Pressures and Weakness in Retail Sales Weigh on the US Dollar and Rates?

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Marc Chandler
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The recent dollar gyrations seem tightly linked to US rates. The FOMC meeting and October jobs report saw the two-year Treasury yield drop 17 bp and the dollar was taken broadly lower. Indeed, against several currency pairs, it approached three standard deviations below its 20-day moving average. What seemed like a mild adjustment to the over-extended technical development turned into a rout after a weak reception to the US 30-year bond auction to finish the quarterly refunding and comments for Fed Chair Powell that did not seem to go beyond his remarks at the post-FOMC press conference, when many insisted he was dovish. The two-year yield rose nearly 17 bp last week. Against several of the major currencies, the dollar closed higher in the first four sessions last week before slipping a head of the weekend.  

While the greenback's technical tone has improved, we expect next week's high-frequency US data to show that price pressures are easing again after stalling in Q3, and more importantly, consumer demand, which fueled the heady Q3 growth to have cooled. So, while Powell assures us that the Fed is prepared to act, if necessary, we look for the market to conclude that it will not be necessary. This may see US interest rates and the dollar soften. Biden and Xi may meet on the sidelines of the APEC summit and it follows a number of high-level meetings. Many portray this as a thaw in the relationship. Yet, talk without a change in behavior perversely strengthens the hawks on both sides by showing diplomatic channels have not produced the desired results. Spending authorization for the US federal government is exhausted on November 17. Without Congress passing another continuing resolution, or a full-year appropriations bill, a partial government shutdown may be unavoidable.

United States:  There are two key data points in the week ahead:  consumer prices and retail sales. After the year-over-year slowing in consumer prices stalled in June at 3.0%, Headline CPI rose to 3.2% in July, 3.7% in August and remained there in September. It likely moved lower in October. The median forecast in Bloomberg's survey is for a 0.1% increase in headline CPI in October. That would allow the year-over-year rate to slow to 3.3%-3.4%. Recall it as at 7.7% last October. The core rate continues to be stickier. The median forecast in Bloomberg's survey is for a 0.3% increase, which would likely keep the 12-month rate at 4.1%. That would be the first time since March that it hasn't fallen. For Fed officials to have more confidence that it is convincingly moving toward its inflation target, demand needs to cool. Consumer spending rose by 4% in Q3. We already know that auto sales slowed slightly in October (15.50 mln saar vs 15.67 mln in September). October retail sales are expected to have fallen for the first time since March. Retail sales are largely about goods purchases. Last year, Americans spent roughly $5.9 trillion on goods and $11.4 trillion on services. Without a slowing in US consumption, the dominant economic slowdown narrative, which has fanned speculation in the Fed funds futures and swap market that the Fed will cut three times, and maybe four, next year, will be called into question. To be sure, there are other high-frequency data points in the week ahead--including PPI, industrial production, housing starts and the TIC report on international capital flows. But, in terms of significance for investors and policymakers, the CPI and retail sales are the story. Ahead the weekend, Moody's cut the US rating outlook to negative.  Recall over a decade ago, S&P took the the US triple-A rating away and Fitch did so a few months ago.  Moody's decision is unlikely to have much material impact. It is more embarrassing than substantive. 

We were concerned last week that the dollar's sell-off was too sharp, with the Dollar Index approaching three standard deviations below its 20-day moving average. It snapped back in recent days and retraced half of its drop from November 1. That retracement is near 106.00. The next retracement (61.8%) is around 106.25. Initial support is likely in the 105.30-40 area. The Dollar Index made a new high for the week before the weekend but drifted lower and snapped the four-day advance. The recent price action seems to underscore the link between the dollar and US rates. If this holds, and next week's US data is as soft as projected, it would seem to be consistent with softer rates and dollar.

China: The October PMIs told two stories. First, that the world's second-largest economy is weak, even if this year's GDP target of 5% is within reach. Second, that the material impact of the new policy initiatives from Beijing are yet to be felt, though some signs of a marshalling of financial resources are evident in the capital markets. Still, based on the new fiscal measures, the IMF revised up by 0.4% its forecast for China's growth to 5.4% this year and 4.6% in 2024. While October bank and shadow bank (e.g., securities firms, insurance companies, fund houses, and trust funds) lending may have slowed, the central and local governments sold a record amount of bonds. This may have contributed, alongside the regulatory requirements and corporate tax date to the liquidity squeeze seen at the end of last month. Still, the point is that the market may not pay much attention to China's economic reports that include retail sales, industrial output, investment, and the surveyed jobless rate. Things do not appear to have changed much in October, though the extended national holiday may have boosted retail sales. More importantly, the PBOC sets the benchmark one-year Medium-Term Lending Facility rate (November 15), currently at 2.50%, where it has been since August. Given the deepening of deflationary forces, the stabilization of the yuan, and equities, a rate cut would be consistent with providing the economy with more support. Nevertheless, a rate cut would catch the market by surprise. Of the eleven economists in Bloomberg's poll, only two look for a cut and they are split between five and 10 bp. 

For the better part of three months now, the dollar has traded in a CNY7.25-CNY7.35 range, with a couple of minor exceptions. The greenback finished last week near CNY7.2855 after making new highs for the week (~CNY7.2935). Beijing has engineered the broadly steady dollar-yuan exchange rate through formal and informal mechanisms. The exchange rate still seems to reflect the broad dollar movement rather than "manipulation" for commercial advantage by Beijing, and the US Treasury recognized this in its semiannual report, though continued to press for more transparency. Over the past 30 sessions, the correlation between changes in the yuan and Dollar Index has risen to near 0.65, the highest in four months.

Japan:  The Japanese economy appears to have contracted in Q3. The median forecast in Bloomberg's survey looks for a 0.4% annualized contraction in Q3. The domestic economy likely did better in Q3 than quarter 2, when consumer spending fell by 2.5% and private investment fell by 4%. However, the net exports contribution (12.9% annualized quarterly rise in exports, especially hospitality services, i.e., tourism, and a 16.5% annualized decline in imports) will not be repeated in Q3. Industrial output is also expected to have fallen. That said, more fiscal support is on the way, but it looks to more of next year's story than this year. The extension of the energy subsidies serves to dampen measured inflation, but when they end (next April), it will pose another challenge for the central bank. The core measure that it targets includes energy. Separately, the last currency account data showed Japanese investors bought JPY3.3 trillion of US bonds in September. That brings this year's total to about JPY15.6 trillion (~$111.7 bln). Recall that the BOJ doubled the 10-year JGB cap to 0.50% last December and again at the end of July (to 1.0%). The higher yields available at home did not deter Japanese investors from exporting savings abroad.

The dollar rose every day last week against the yen. That is the first time this has taken place since August. After settling near JPY149.40 after the US employment data on November 3, the dollar rose to a high around JPY151.65. The high for the year was set on October 31 slightly above JPY151.70 and last year's high was closer to JPY151.95. Despite the apparent one-way market in recent days, one-month implied volatility remains in its trough (~7.1%), less than half of what was prevailing last September and October when the BOJ intervened. It is notable in the absence that neither US nor European officials have pushed back against the persistent yen weakness. The yen is near its lowest level against the dollar since 1998 and is weakest against the euro since 2008. 

Eurozone: Eurostat may revise its preliminary estimate that the eurozone economy contracted by 0.1% in Q3 and provide details, which likely see weakness in consumption and industrial output. But barring a significant surprise, the market will have to look elsewhere for new incentives. There have been couple pieces of Q4 data so far: the October composite PMI, which declined further and a sharp drop in the CPI to 2.9% year-over-year from 4.3% in September. The CPI estimate is subject to revision, but it will not change the underlying picture. Moreover, given the base effect, this is probably the low point in the for the next few months. Note that at the end of the week, Fitch updates its credit rating of Italy. It has a negative outlook to its assessment that Italy is one step into investment grade. There is little margin here. A downgrade would likely spark a sell-off in Italian bonds and could drag the euro lower, but the use of Italian bonds as collateral in operations with the ECB would be unimpaired (ECB takes the highest rating of the top four rating agencies). Italy's 10-year premium over Germany peaked a month ago near 205 bp, the high since early January. It finished the week near 186 bp, about six bp above the 200-day moving average. The two-year premium rose to a one-year high of almost 95 bp in mid-October. It finished last week near 72 bp. 

After the US employment data, the euro had been around three standard deviations above its 20-day moving average. The subsequent pullback has been rather mild when everything is considered. It overshot the (38.2%) retracement objective (~$1.0665) on an intraday basis but has not settled below it. The next retracement (~50%) is about $1.0635. The consolidative pattern in recent days still looks constructive (as in a flag or pennant) but it needs to be resolved shortly. Since the high was set on November 6 near $1.0755, the euro has met resistance in the $1.0720-25 area. 

United Kingdom: There are two UK reports next week that the market is particularly sensitive to, namely employment/wages, and CPI. The labor market is cooling but the sticky wages may have encouraged three MPC officials to support a rate hike at last week's meeting. That said, wage growth appears to have peaked and may have slowed for the second consecutive month in September. The following day (November 15), the UK reports October CPI, and the BOE warned of a sharp decline. This was hardly a leak, and more like stating the obvious. In October 2022, the UK's CPI surged by 2.0%. This will drop out of the 12-month comparison and be replaced with a much smaller number. A 0.3% increase would allow the year-over-year rate to fall to 5.0% from 6.7%. If true, it would be the slowest pace in two years. Last week, the BOE's chief economist Pill validated market expectations (~60%) of a rate cut around the middle of next year by calling them in British fashion, not "totally unreasonable." As recently as October 18, the swaps market was pricing in a 50% chance of another hike by mid-2024. The UK also reports October retail sales. They appear to have stabilized after falling 0.9% in September and at an annualized rate of 6.4% in Q3 (after a 4.4% annualized increase in Q2). 

Sterling made a marginal new low ahead of the weekend a little below $1.2190 after the slightly better than expected Q3 GDP (stagnation rather than a small contraction). It overshot the (61.8%) retracement objective of the rally from the November 1 low (~$1.2095) to the November 6 high (almost $1.2430), found near $1.2225. A late recovery allowed it to snap a four-day losing streak. It settled slightly above $1.2220, which may help stabilize the tone, but more formidable resistance may be seen in the $1.2255-70 area. 

Australia: The Reserve Bank of Australia boosted its inflation forecast and reduced the peak level of unemployment it projects. It now sees inflation returning toward 3%, the top of its target range in late 2025 and is about 25 bp higher than the August projection. The wording of the statement shifted from suggesting that further tightening "may be required," to saying that the economic data going forward will determine "whether" it has done enough. Two data points stand out in the coming days. First is the Q3 wage index. Hourly wages have risen by about 0.9% a quarter for the past four quarters. This represents a doubling of the pace seen in the four quarters through the middle of last year. Second is the labor market itself. The October employment report is released early on November 16. Job growth has slowed. The three-month average through September was 23.1k a month, which is half the pace seen in Q1. It gets worse. Australia has lost an average of almost 18k full-time jobs in Q3. It was the first time the three-month average has been negative since October 2021. Still, the increase in the labor market has slowed too, and this has kept the unemployment rate in the 3.5%-3.7% range since late last year. 

The Australian dollar fell every day last week. That has not happened since August 2022. Despite the quarter-point rate hike that had not been fully discounted in the futures or swap market, the Aussie got tagged for a nearly 2.4% loss, the largest in five months. The drop surpassed the (61.8%) retracement of its recovery from the year's low on October 26 (~$0.6270). The momentum indicators have turned lower, and nearby support is seen around $0.6320-30. A move back above the $0.6415 area may be needed to stabilize the technical tone. m

Canada: The economic data in the coming days typically are not market-movers. Housing starts through September are running about 8% below last year's pace. Existing home sales did fine in the first half, rising by an average of 3.1% a month. They hit a wall in Q3, falling every month (average -2.2%). October's reports will be interesting but unlikely to change sentiment that sees the risk of recession. Canada also reports its September portfolio capital flows. Foreign investors continue to buy Canadian stocks and bonds but on a net basis it has slowed dramatically. In the first eight months of the year, foreign investors purchased a net of about C$37.5 bln of Canada's stocks and bonds. In the same period last year, foreign portfolio capital inflows were almost C$125 bln. The summary of the last Bank of Canada meeting showed that there are at least a couple of board members that favor a tighter monetary policy to address the resilient core pressures. Others, apparently the majority, expect the softer economy will dampen price pressures. However, they caution that the (2.5%) increase in federal and provincial spending pushes in the other direction. Still, the swap market has a little more than an 80% chance of a cut by the end of Q2 24, with two cuts fully discounted by the end of next October.

The Canadian dollar was set to fall for the fifth consecutive session ahead of the weekend, but a late recovery helped avoid it. It eked out less than a 0.1% gain before the weekend to trip the week's loss to about 1%. Before the weekend, the US dollar reached CAD1.3855, a new high for the week. Here, too, the greenback has surpassed the (61.8%) retracement objective of the recent decline. The persistent US dollar gains have turned the momentum indicators higher. There seems to be little on the charts in front of the year's high set on November 1 near CAD1.3900, but the close below CAD1.3800, albeit marginally, seemed may suggest a weaker tone may emerged. Initial support may be around CAD1.3750. 

Mexico:  Mexico's vehicle output is exceptionally strong. October's output was almost 36% higher than October 2022. Year-to-date, auto and light truck output is up half as much, which is still better than solid. Exports of the vehicles (primarily to the US) were 18% higher last month than in October 2022. In October, Mexico exported about 84% of the vehicles it produced. Separately, Mexico reported another gradual slowing of headline and core inflation. There was little doubt that Banxico would keep the overnight rate at 11.25% at its meeting last week. Banxico cut the end of the year's inflation forecast to 4.4% from 4.7% and sees CPI at 4.4% in Q4 23. It modified its language around the target rate. It changed the reference from keeping it at 11.2%% for "an extended period" to "for some time." It seemed to bolster the market's expectation for a rate cut in Q2 24, ahead of the June 1 general election. The combination of Banxico and Fed Chair Powell's comments that market took as more hawkish, lifted the greenback from around MXN17.50 to almost MXN17.94 ahead of the weekend. The dollar stalled near the 20-day moving average and did not quite retrace (61.8%) of the decline from the October 26 high (~MXN18.4245) found slightly below MXN17.9885. With the help of stronger than expected manufacturing output in September (0.8% vs. median forecast in Bloomberg's survey of a 1.7% decline), the dollar reversed lower and finished the week back below the 200-day moving average (~MSN17.68). Initial support now is seen in the MXN17.50-60 area.