Week Ahead: US Dollar Poised to Extend Gains

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Marc Chandler
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Two of the most tumultuous weeks of the year are behind us. The sweeping GOP victory in the US cannot be considered anything but a mandate. The shock experienced in 2016 is not being repeated, but there is limited visibility  Perhaps, the stance articulated at the press conference by Fed Chair Powell that the central bank does not "guess, speculate, or assume" about the policies of the next administration and the impact on efforts to achieve the dual mandate of full employment and stable prices is a good starting point for investors and businesses. One need not accept modern monetary theory to recognize cases, for example, where large deficit coincided with falling inflation. There are other variables in addition to budget deficits and tariffs that influence changes in the general price level. After the jump in US interest rates and the dollar in the immediate aftermath of election, consolidation characterized the last couple of sessions. That consolidation looks favorable for the dollar. 

It may take market participants some time to re-learn lessons from 2016-2020, which include to take Trump seriously even if not literally. His transactional thrust means some of the tariff threats, for example, may be negotiating positions. However, German and Japanese politics are also in flux. The German government is in disarray following the dismissal of Finance Minister Linder. Chancellor Scholz did not want to have an election until March, but pressure is building to hold it in January. Japan's new Diet votes for a prime minister on Monday, and without a more unified opposition, the LDP's Ishida will likely hold the post, and lead a minority government. High-frequency economic data highlights include the US October CPI (headline likely ticked higher), UK and Japan's Q3 GDP, Australia's employment data, and the central bank of Mexico meeting (a quarter-point rate cut is the most likely scenario). 

United States:  Without declaring victory over inflation, Federal Reserve officials have expressed confidence that prices are on a sustainable path to the 2% target, which allows greater attention to the other mandate, full employment. Nevertheless, the monthly CPI report remains arguably the most important high-frequency economic report in the monthly cycle. Its rival, the nonfarm payroll report, is skewed by the low establishment participation rate, persistent downward revisions, and one-off distortions. The October CPI may tick up, but the Federal Reserve will have another reading in hand before next month's meeting, and Chair Powell acknowledged that the central bank accepted it would be a bumpy path. Consumer prices may have risen by 0.2% last month, and given the base effect, it points to a 2.5% year-over-year rate, up from 2.4%. It would be the first rise in the year-over-year rate since March, and the fourth consecutive 0.2% monthly increase. The core rate continues to be stickier. The core CPI is expected to have risen by 0.3% for the third consecutive month. Given that it rose by 0.2% in October 2023, year-over-year rate may tick up to 3.4%, depending on the rounding, which would be the highest since May. Producer price inflation also is expected to have accelerated in October. In addition to the price gauges, October retail sales and industrial production reports due. We already know that auto sales improved. The 16.04 mln unit seasonally adjusted annual pace was the most since May 2021 and the average through October was 15.6 mln compared with 15.4 mln in October 2023. Retail sales may have grown by 0.3% after a 0.4% increase in September. Separately, industrial output may have contracted by 0.2%. If so, it would be the sixth month so far this year that industrial production fell. It fell in only four months in 2023. After growing by a preliminary estimate of 2.8% in Q3, the US economic growth is expected to slow to around 1.7% here in Q4. Lastly, the Senior Loan Officer Survey may take on greater importance that usual. Since late September, the US two-year yield has risen by nearly 80 bp and the 10-year yield has risen by almost 90 bp. The 2-10-year US yield curve re-inverted from around 50 bp inversion at the end of Q2 to positively sloped by around 20 bp at the end of Q3 and is hovering near 10-15 bp. The sharp shifts in interest rates makes for a challenging time for businesses and banks.

The Dollar Index was sold to a two-week low (~~103.35) as American were voting last Tuesday. It gapped higher on Wednesday and reached a four-month high (~105.45). The choppy trading seems more likely bullish consolidation. Last Wednesday's range is key (~104.00-105.45). The high for the year seen in mid-April near 106.50.

China: Some of Beijing's initiatives will likely begin impacting China's high-frequency economic data, one would imagine. The October PMI was a little better than expected. Yet, prices have not responded. October CPI slowed to 0.3% year-over-year from 0.4%, while PPI fell 2.9% year-over-year (from -2.8%in September). Food price inflation slowed to 2.9% from 3.3%, while the core rate edged up to 0.2% from 0.1% year-over-year. Data in the coming days may show the decline in new and used house prices moderated last month, while industrial production and retail sales improved. Property investment likely remains weak but residential sales implosion may be slowing. Investors still look for more initiatives to support the economy.

The dollar looks poised to move higher against the Chinese yuan. Against the offshore yuan, the greenback can move into the CNH7.25 area in the near-term, which it has not seen in three months. Further out, a return to the CNH7.30 seen in July is possible. Of course, such a modest move will hardly blunt the tariffs Trump has threatened. The PBOC set the dollar's reference rate sharply lower last Thursday, demonstrating a willingness to manage the depreciation of the yuan. 

Japan:  Japan is recording a growing current account surplus but is struggling to recycle it via capital outflows. Japan will report the September current account before the markets open on Monday. Through August, Japan's current account surplus is running about 50% higher than a year ago (~JPY19.7 trillion vs. JPY13.04 trillion). What is sometime lost by observers is that despite the current account surplus Japan runs a trade deficit. The trade deficit has averaged almost JPY3.5 trillion through August. The current account surplus reflects tourism and returns on past investments (e.g., profits, interest, royalties, and licensing fees). Japanese investors continue to buy foreign assets, but at a pace slightly less than half from a year ago, while foreign investors, for their part, are net buyers of Japanese assets this year after they were net sellers in the first 10 months of last year. Japan reports its first estimate for Q3 GDP on November 15. Growth may slow from almost 3% at annualized rate in Q2 to about 1.5% in Q3, as consumption and investment slowed, while government spending may have increased. Meanwhile, Japan's political situation is expected to be resolved shortly. A vote for the prime minister could be held as early as November 11. If most of the individual parties vote for their own leader, as looks likely, rather than coordinate efforts and support a single alternative, Ishiba would likely be returned as prime minister. The LDP and Komeito, its coalition partner, would still have to rely on others' support to pass legislation, including the budget and supplemental spending bill. 

The jump in US rates following the election, lifted the dollar to almost JPY155, its best level since late July. As US rates consolidated, so did the exchange rate. Wednesday's range (~JPY151.30-JPY154.70) continues to define the price action. The momentum indicators have turned lower but sometimes it is consistent with sideways price action. Still, the dollar snapped a five-week advance against the yen and slipped by about 0.20%. 

Eurozone: With industrial output falling in Germany (-1.0%), France (-0.6%), and Italy (-0.5%), the weakness in the aggregate report on November 13 is baked in the cake. But with Q3 GDP already in hand (revision and details due November 14), the industrial output disappointment is unlikely to be a market mover. The EU Commission updates its economic forecast at the end of the week. The ECB's last meeting of the year is December 12. The swaps market sees a modest chance of a 50 bp cut (less than 20%) and over the next three meetings has nearly 83 bp of easing discounted (or about a 1-in-3 chance of a half-point move). Lastly, on November 12, the German Constitutional Court will hear arguments that question the legality of the solidarity tax. Through 2020, almost all German taxpayers were required to pay the tax, but changes mean that around 90% are exempt. The German government itself is in disarray following the dismissal of the finance minister Linder, who presented the FDP in the coalition government. Chancellor Scholz does not want to call for an immediate election, preferring a March data, but the CDU/CSU, which would most likely lead the next government, want it considerably sooner. 

The euro tumbled from around $1.0935 to slightly below $1.0665 in the immediate response to Trump's re-election. It has not been above $1.0825 since the low was recorded. and it settled week  poorly, falling to almost $1.0685. With the US two-year premium over Germany pushing back above 200 bp, the risk remains on euro's downside. The low for the euro was set in mid-April near $1.06. The euro fell by about 1.2% last week, the largest week loss in five weeks, and three-quarters of it was recorded before the weekend. 

United Kingdom: The Bank of England's decision at the December meeting does not hinge on jobs report and Q3 GDP to be released in the coming days. The continued slowing of wage growth will affirm the direction of policy and has allowed the BOE to deliver two rate cuts already this year. The swaps market is discounting about 50 bp of cuts in H1 25. Recall that the UK economy contracted in H2 23 and rebounded smartly in H1 24; expanded by 0.7% in Q1 and 0.5% in Q2. The September and Q3 GDP will be reported on November 15. Growth may have slowed to 0.3%, but the year-over-year pace may be around 1%, which would be strongest since Q4 22. 

Sterling's losses were extended for the sixth consecutive week.  It has not risen on a weekly basis since the end of September.  Sterling had been up about 0.5% coming into the pre-weekend session. The downside does not appear to have been exhausted with the post-US election low (~$1.2835). It may require a break of $1.2800 to signal the next leg down, which could extend toward the August low (~$1.2665). The $1.3000-$1.3050 area may now offer formidable resistance. 

Australia:  Australia reports its Q3 wage index on November 13 and the October employment report on November 14. Wage growth accelerated in 2022 and 2023 but is moderating this year. The quarterly pace H1 was slightly 0.85%. That is the slowest since H1 22. In the two years before the pandemic, the quarterly average was about 0.55%. Australian job growth has been running slightly better than last year. Through September, Australia created 373.5k jobs, up from almost 317k jobs in the first nine months of 2023. Of those jobs, 291k were full-time posts this year and 143k a year ago. The Reserve Bank of Australia has little sense of urgency regarding interest rates. It has persuaded the market that it will not hike rates this year. The futures market has a little more than a 65% chance that the first cut is delivered in April 2025. The market has two cuts fully discounted next year. 

Last week, the Australian dollar rose, albeit, ever so slightly, for the first time since the end of September. The Aussie may have been helped by a sense that Sydney has not antagonized the US President-elect, the central bank's reluctance to join the monetary easing parade, and perhaps, there is a role being a proxy for China. Still, the price action ahead of the weekend was uninspiring and it settled below Thursday's low (~$0.6565). Last week's low was closer to $0.6515, and a band of support may be $0.6470-$0.6500.  

Canada: The Bank of Canada slashed its target rate by 125 bp this year and the swaps market is discounting slightly more than a 50% chance of another half point cut when it meets next month, practically unchanged on the week. We are less sanguine after the October PMI, employment report and the continued weakness of the Canadian dollar. The composite PMI jumped from 47.0, the low since January to a new high since April 2023 (50.7). There is also the continued port strike and politics tensions have risen as the Bloc Quebecois has joined the Conservatives in trying to topple the Liberal minority government. The NDP still refuses to join the effort. It arguable would lose more in a Conservative government than with the weakened Trudeau.

The US dollar rallied from around CAD1.3820 to CAD1.3960, a marginal new high for the year in the middle of last week amid the dramatic response to the US election. It remained in that range in the last two sessions, but the consolidation looks US-dollar friendly, and a new high seems likely. The US two-year premium over Canada edged a little close to 115 bp, the most in 27 years. The CAD1.40 area is the next obvious chart area of note. The greenback has not traded above it since May 2020. 

Mexico:  Mexico reports September industrial production on November 11 ahead of the central bank meeting on October 14. Industrial output slipped by 0.5% in August and likely recovered in September. The central bank is a close call. The economy appears to be slowing, but headline inflation is higher on the year, even though the core rate continues to ease. The peso has depreciated sharply since the end of May, when politics began dominating. It is off more than 16%, making it the worst performing currency in the world. 

Three Latam currencies led emerging market currencies higher last week. The Colombian peso was the leader with a 1.8% rally, followed by the 1.5% rise of the Brazilian real (backed by the central bank's 50 bp rate hike).  The Mexican peso eked out a minor gain of 0.2% after it was tagged for nearly 2.2% before the weekend.  Given use of Mexico by US multinationals for labor-intensive assembly work and to circumvent tariffs on Chinese goods, the kind of levy Trump threatened Mexico with should be understood as a negotiating position. The US dollar reached MXN20.8070 in the middle of last week but posted the highest close last week ahead of the weekend near MXN20.25.