Week Ahead: Buckle Up–Turbulence Coming

by
Marc Chandler
My articles My siteAbout meMy booksMy videos
Follow on:TwitterLinkedIN
Seeking Alpha

The US dollar extended its dramatic recovery against the major currencies for the fourth consecutive week. The dollar's rally seems to stand on two-legs. The first shift in the expected trajectory of Fed policy, which has been partly encouraged by relatively firm economic data, both surveys and real sector reports. The derivatives market has from discounting 75 bp of cuts before the end of the year to not be quite sure that 50 bp will be delivered. This leg may be questioned if as we expect that jobs growth slowed considerably this month. However, given the storms and strikes, it will not be a clean report. The second leg the dollar is standing is the conclusion reached by some large pools of capital that despite Trump/Vance preference for a weaker dollar that their victory will likely lead to a stronger dollar through the interest rate channel and the headwinds on the US trading partners from a generalized tariff increase. 

The next couple of weeks will be dramatic. Next week features the Japanese election on October 27, the UK budget, which may be tighter on a day-to-day basis, but scope for new public investment, Bank of Japan meeting, preliminary eurozone October CPI (small tick up is likely), and the US employment data (which will likely show a dramatic reduction in jobs growth after the 254k increase in September). The US Treasury makes its refunding announcement and will sell more than $600 bln in bills and coupons. The backing up of rates has built in a concession, but it could mark the highwater point in rates, especially if the jobs report is weak. 

United States: There is a high-frequency US data point every day in the week ahead. The most important is the October employment report. US rates appeared to have been bottoming in the days after the FOMC delivered the 50 bp rate cut to begin the easing cycle, but it was the stronger than expected September jobs report that spurred a dramatic interest rate and dollar response. Ten days after the September FOMC meeting and an updated dot plot that showed the median Fed projection for two quarter-point cuts in Q4, the Fed funds futures were still discounting 75 bp of cuts. The risk is that the September employment was an anomaly. The trend is clearly toward a slowing of job growth. In the three months through August, for example, nonfarm payrolls rose by an average of 140k a month, the least since the end of H1 20. The unemployment rate rose from 3.7% in January to 4.3% in July before dipping to 4.2% in August. The median forecast in Bloomberg's survey is for 108k increase in nonfarm payrolls in October, and given the climate and industrial disruptions, the risk may be on the downside. Moreover, the manufacturing revival in the US apparently is not extending to employment. Through August, manufacturing employment has fallen by 40k this year. In the first eight months of 2023, the US gained less than 10k manufacturing jobs. Before the jobs report, the US will provide its first estimate for Q3 GDP (October 30). The median forecast in Bloomberg's survey has steadily crept up and now stands at 3.0%, the same as in Q2. The Atlanta Fed's tracker is at 3.4%. The GDP report will incorporate the next day's data--September personal income and consumption (both seen rising by 0.4% after 0.2% gains in August). The deflators are also due, but after the CPI and PPI, economists have a particularly good handle on them. CPI and PPI may surprise; PCE deflator much less so. A 0.2% rise in the headline PCE deflator will allow the year-over-year rate to slip to 2.1%, the lowest since February 2021. This is the measure that the Fed targets, yet many in the media insist on referring to the core rate as the Fed's preferred measure. If it were truly preferred, wouldn't it be the targeted measure? When Fed Chair Powell and others, like Governor Waller, explained the rational for cutting by 50 bp last month, they did not cite the core PCE deflator. They did not cite the headline deflator. They both cited the CPI reported that was released during the Fed's self-imposed quiet period.

The Dollar Index rose for the fourth consecutive week, matching its longest advance since February. It peaked slightly above 104.55 in the middle of last week before consolidating in the last couple of sessions. The 104.80-105.00 area is the next hurdle. A band of support is between about 103.40-80. If this area were to yield, the momentum indicators would likely turn down. Ideas that a Trump victory is good for the dollar, despite his calls for a more competitive currency, remains a potent force. 

Japan: The election for the lower chamber of the Diet takes place October 27. Some recent polls suggest it is possible that the LDP loses its outright majority, for the first time since 2009. Still, with its coalition partner Komeito, the governing coalition is expected to be returned. The failure of the LDP to secure an outright majority may not make for a substantial change in policy. Anticipating his own mandate, Prime Minister Ishiba is already having his team cobble together a new support package aimed at cushioning impact of higher prices, and this could take the form of extended household energy subsidies. Other measures, including cash transfer to low-income households is also expected. The package could be around JPY17 trillion or close to $100 bln. The Bank of Japan's meeting concludes on October 31. The market accepts that there is little chance of a change in policy, yet. The swaps market is pricing in nearly nine basis points of tightening at the December meeting and has a 15 bp increase discounted by the end of January and 25bp by the end of H1 25. The BOJ will update its economic forecasts. In July, it anticipated 1% growth this fiscal year and next, while core CPI was going to be at 2.5% this year (it was at 2.4% in September), it was seen easing to 2.1% in the next fiscal year and 1.9% in FY26. 

The rise in US 10-year yields continued to fuel the dollar's gain against the yen. The greenback reached JPY153.20 in the middle last week as the 10-year yield peaked a little above 4.25%. Japanese officials have been unusually quiet as the dollar rose against the yen for the fourth consecutive week. The JPY153.40 area corresponds to the (61.8%) retracement of the dollar's fall from the high near JPY162 in early July (to the mid-September low ~JPY139.60), and a move above there could spur gains to JPY155 as the markets begin probing for the pain threshold of officials. Initial support in the JPY151.40 area was tested before the weekend and it held. It may take a break of JPY151 to be any of note from a technical perspective. 

Eurozone: The euro area has little forward economic momentum. The regional economy grew by about 0.5% in H1 and is expected to grow by 0.2% in Q3 and Q4, before economists expect growth to pick up next year. The IMF is slightly more optimistic that the European Central Bank. The ECB's updated forecast in September anticipated 0.8% growth this year, rising to 1.3% in 2025. The IMF estimate the eurozone economy to grow by 0.9% this year and 1.5% next. Germany, the largest economy in the region, has not managed to string two quarterly expansions since Q4 21and Q1 22. In a recent report, former ECB President and Italian Prime Minister, Draghi argued the EU was faced with three options: integration, exit, and paralysis. From the outside, it looks as if paralysis is being chosen by default. The eurozone's preliminary estimate for October CPI is due October 31. The eurozone's CPI was flat in Q3, and was 1.8% year-over-year in September, the lowest since April 2021. There is risk that eurozone CPI ticks higher in October and November when the base effect makes for difficult comparisons. Recall that in October 2023, eurozone CPI rose by 01% and fell by 0.6% in November. There is speculation of a 50 bp cut by the ECB in December. The swaps market discounts about a 40% chance of a half-point cut, which strikes us as somewhat exaggerated. 

The euro has not risen for five weeks. It fell to almost $1.0760 in the middle of last week before it recovered to $1.0840 ahead of the weekend. But it is struggling to maintain even the most modest of upticks and was unable to hold above $1.08 and dribbled $1.0790. The price action is not inspiring and last week's low doesn't look safe.  The euro's descent has tracked the widening of the US two-year premium over Germany. It has risen from about 135 bp in mid-September to above 200 bp last week. The premium narrowed for the first time in nine sessions ahead of the weekend. It needs to continue if the euro is going to forge a bottom. 

UK: The UK sees mortgage and consumer credit reports in the coming days. Not only are they typically not market-moving but there is something more significant for investors: the Autumn budget on October 30. Sticking with a traditional narrative may backfire on Labour. This common narrative is to play up the poor shape of government finances left by the previous government. The brave and decisive action by the new government saves the country. Long live the King. Chancellor Reeves claims the Tories left a GBP22 bln hole and in the first hundred days or so in offices, which will likely justify some tax increases. Recall that the former chancellor was able to fund the pre-election tax cuts by projecting a steep reduction in expenditures post-election. Reeves will adopt a different metric (namely, the Public Sector Net Financial Liabilities) which will create space for an estimated GBP50 bln, even if it is not all used. The doom and gloom handwringing has been blamed for the erosion of consumer confidence, while investors and businesses are anxious about the revenue-enhancement measures (taxes). Prime Minister Starmer campaigned to "relight the fire of optimism," but it is to be found only in its absence now. The market is confident that the Bank of England will deliver its second cut in the cycle on November 7. Pricing in the swaps market is consistent with about a 65% chance of another cut in December, down from slightly above 75% a week ago. 

Sterling's four-week decline is the longest this year. After peaking in late September around $1.3435, the sell-off brought it nearly $1.29 last week. Its recovery stalled near $1.30 before the weekend and it settled near session lows. It looks poised to test $1.2900 again and a break could open the door to another leg down; perhaps another cent.  

Australia:  The Reserve Bank of Australia meets on November 5 and the quarterly CPI that will be reported on October 30 will likely have negligible impact on the decision. However, a fall in line with the monthly print to below 3% from 3.9% in Q2 could encourage the market to bring forward the rate cut for which the market is not fully discounting until next April. The RBA is concerned that demand in running ahead of supply, but inflation adjusted retail sales, and the broader measure of household spending warns that demand may be waning. 

The Australian dollar's four-week decline took it to $0.6600 at the end of last week. It peaked at the end of September slightly above $0.6940. It frayed the 200-day moving average (~$0.6630) in each of the past three sessions and finally settled below it before the weekend.  The low at the end of last week was a new low since mid-August and does not seem complete. The next retracement (61.8%) is closer to $0.6575. A move above $0.6660 is needed to stabilize the tone. 

Canada: With last week's 50 bp rate cut, the Bank of Canada secured its place as the most aggressive central bank, having cut its target rate by 125 bp since the easing cycle began in June. And it is not done. The swaps market has a little more than a 1-in-3 chance of another 50 bp cut in December. The market risks getting ahead of itself. Underlying core inflation is 2.3%-2.4%, while the headline has fallen to 1.6%. Also, the Canadian economy is expanding modestly. The monthly GDP has risen by an average of 0.2% in the first seven months of the year compared with 0.1% in January-July 2023 period. Political risk is rising the end of the month is approached. The minority Liberal government may lose the support of Bloc Quebecois at the end of the month, which has threatened to support a no-confidence motion. The Conservatives support it but need the Quebecois and the New Democratic Party to succeed. 

The sell-off in the Canadian dollar does not look over after falling nearly 2.7% in its four-week slide. The US dollar posted its highest settlement before the weekend since August 2. As is often the case in a strong US dollar environment, the Canadian dollar typically holds up well on the crosses. So far, this month, the Canadian dollar is second best G10 currency behind the Swiss franc (~-2.4%). There seems little to prevent a test on the year's high set in August near CAD1.3945 and the late 2022 high closer to CAD1.3975. The US dollar has not been above CAD1.40 since the early days of the pandemic. Support is seen near CAD1.38. 

Mexico:  There are several data points in the coming days that will show how the Mexican economy is performing. They include Q3 GDP, September trade, unemployment, and remittances. However, in terms of the peso and monetary policy, the data may get short shrift as the focus is on the implications of the US election, and a possible Trump victory. Mexico is seen as one of the most vulnerable to Trump's tariffs and threat to the auto industry built there may exports heavily into the US. The central bank meets on November 14. The recent weakness of the peso has contributed to the market's cautious outlook for Banxico. Moreover, headline inflation rose for the first time in three months in the first half of October. The swaps market has about a 33% chance of a cut discounted. 

The US dollar peaked the middle of last week near MXN20.0950, its highest level in a month. It has traded above MXN20.00 four times since the middle of the month but has not settled above it once. It looks poised to do so next week. At the same time that the peso is seen vulnerable to a second Trump term, it has held up fairly well so far this month. The peso is off about 1.4%, making it the fifth best performer among emerging market currencies (after the Hong Kong dollar, which is the only G10/EM currency not to have fallen this month, the Turkish lira, off about 0.25% and the Indian rupee, which has slipped almost 0.35% and the Taiwanese dollar down 1.3%). While the momentum indicators are stretched, the market has not given up on the MXN20.00 level. Recall that the early August high as carry-trades were being unwound, the greenback reached MXN20.2180. 

China:  Beijing reports the October PMI on October 31 and the Caixin manufacturing PMI on November 1. It may still be too early to see much impact from various measures taken to support the property and stock markets and the attempt to de-risk local government finances. The dollar edged up slightly last week against the offshore yuan (~0.15%) but the greenback remains in a CNH7.10-CNH7.15 band. The correlation with changes in the yen has weakened as idiosyncratic developments have dominated lately, but like other, less managed exchange rates, the yuan weakened this month after strengthening August and September. When the dollar turns down against the G7 currencies, it still seems likely that it retreats against the yuan as well. The yuan is practically flat against the dollar this year, which means it has appreciated more than 7% against the Japanese yen and South Korean won. The only G10 currency it has not appreciated against is sterling.