Week Ahead: Is the US Rate Adjustment Nearly Over? Be On Guard for Reversal Patterns

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Marc Chandler
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The combination of the stronger-than-expected US September jobs report and the slightly firmer inflation readings lifted US interest rates and the dollar. Several Fed officials spoke, and it did not appear that the employment or price reports changed views as much as it had impacted the capital markets. The September Summary of Economic Projections found a median projection (and 10 officials) that 50 bp of cuts in Q4 would be appropriate, but seven thought only one quarter-point cut. On the eve of the jobs report, the Fed funds futures had nearly 67 bp of easing priced in for the remainder of the year. It settled last week with about 45 bp discounted. We suspect the interest rate move is nearly over. For its part, key charts points in the foreign exchange market held on the initial test, such as $1.09 in the euro, $1.30 for sterling, and $0.6700 in the Australian dollar. The momentum indicators have been stretched by the greenback's strong recovery this month. We are anticipating technical evidence to suggest the dollar is peaking. 

After the US jobs and price data have dominated the screens in recent sessions, attention turns to Europe in the coming days. The highlight is the European Central Bank meeting, which will most likely result in a back-to-back cut after the September move. While the doves might have been pushing for one, it was the sub-2% CPI reading that shifted the balance. Market expectations for Bank of England policy will take cues from the UK employment report and CPI/PPI. Slowing earnings growth and a softer CPI report, including services, followed by an outright fall in retail sales may boost speculation of a November and December rate cuts. US will help economists fine tune Q3 GDP forecasts. After retail sales and industrial production are reported on October 17, the Atlanta Fed GDP tracker will be updated. It and the NY Fed's version have converged: 3.1%-3.2%. The median projection of the economists surveyed by Bloomberg was 2.1%. Beijing promised new measures, seemingly aimed at property sector and local governments, while light on details.   

United States: The US high-frequency data do not have the policy implications of US employment data or CPI. What is at stake this week is fine-tuning expectations for Q3 growth, which is still running above what the Federal Reserve regards as the long-term non-inflationary pace. Although the consumer credit growth has slowed, and various measures of household debt stress levels are elevated, the US consumer is still shopping. September retail sales likely were flattered by the rise in auto sales, while industrial production probably slowed after jumping by 0.8% in August. Similarly, housing starts, which surged by a heady 9.6% in August, likely softened. The economic reports pose headline risk but the market's convergence to the Fed's guidance of a 25 bp rate cut in November is unlikely to be disturbed. Policy is still restrictive, even if the precise magnitude is difficult to measure and is subject to dispute. Given the variable lags, monetary policy settings are not so much about current conditions, but the likely economic conditions a quarter or more from now. 

The Dollar Index has rallied 3% from its late September test on the 100 area. The stronger US jobs data and the firm CPI helped the DXY recoup about half of what it low since the late June high (a little above 106). A break of 103.15 could target the 103.75-104.00 area. Still, the momentum indicators are stretched and beginning to look toppish. Caution is advised in chasing DXY higher. Initial support is near 102.50. 

Eurozone:  The market had been comfortable with a 25 bp cut by the ECB quarterly. However, the September inflation reports showed a quick moderation in price pressures than had been anticipated, and the economic impulses remain faint. The four largest members all reported September slowed below 2%. The preliminary aggregate reading was 1.8%. This spurred speculation of a cut this week after the second quarter-point rate cut was delivered last month. In fact, at this juncture, with the pricing in the swap market consistent with more than a 90% chance of a cut, inaction would be more disruptive than a back-to-back cut. The swaps market has a December cut nearly discounted as well. 

The euro held support near $1.09 on October 10, the subsequent bounce was limited to slightly more than half of a cent. A break of $1.09 targets the $1.0875-80 area, but the double top around $1.12 has a measuring objective of $1.08. The euro has already pulled back three cents, and the momentum indicators are getting stretched. What gave us confidence that the $1.12 area was going to hold was that the US two-year premium over Germany was widening and that would prove supportive of the dollar. Now, the opposite is materializing, the US premium is beginning to narrow. It has been reduced in three of the last four sessions. Still, the $1.10 area needs to be overcome to signify anything important from a technical perspective. 

Japan:  The new government is cobbling together a fiscal package that is ostensibly aimed at cushioning the impact of elevated prices on households, while at the same time, expressing caution about the need for additional rate hikes. September CPI will be reported at the end of the week, but it will not impact expectations much. First, economists and the Bank of Japan know that the Tokyo CPI, released a few weeks ago, contains the important signal. Headline and core prices moderated, but the measure that excludes energy as well as fresh food was unchanged. Second, the snap election is a few days before the October 30-31 BOJ meeting. BOJ Governor Ueda sounded cautious, and given the reluctance to surprise the market again (after the dramatic reaction to the July decision to hike and begin QT), there is little doubt that it will stand pat. The swaps market has about eight basis points of tightening discounted for last meeting of the year in December, but many economists are pushing their expectations for the next hike into 2025.

The dollar climbed higher against the yen on the back of the rise in US interest rates. The 10-year Treasury yield rose 12 bp last week, the fourth consecutive weekly advance, and near 4.12%, it reached its highest level since the end of July. The greenback reached JPY149.55, its best level since August 1. The upside potential extends into the JPY150-JPY151 area but may need higher US yields to overcome the stretched momentum indicators. And the US 10-year yield settled near 4.10% and does appear to have potential toward 4.15%-4.20%. 

China:  With the "fiscal briefing" light on the kind of specifics many had expected,  and what was announced seemed like recycling unused or unspent quotas, there is a sense of Beijing "salami tactics"--repeated slices of initiatives until the desired results are achieved. The prospect of another slice from the Standing Committee of the National People's Congress, which meets later this month may keep the disappointment on Monday in check. There is a heavy slate of Chinese economic reports this week starting with the September CPI and PPI, which will be reported before markets open on Monday. Headline CPI is expected to  steady at 0.6%, while deflation likely deepened among producer prices (-2.6% vs. -1.8%), which has knock-on effects on industrial profits.  There will be September real sector reports and the Q3 GDP. However, none of it will matter very much. On the one hand, the yuan's exchange rate is closely managed and Chinese data does not often seem to drive it. On the other hand, the data are less relevant given the large package of rate and required reserve cuts, support for the property and stock markets. The CSI 300 rose nearly 6% on October 8 as mainland markets re-opened from the week-long national holiday. It was the 10th consecutive daily advance, and the CSI 300 rose by nearly 35% over the run. It stumbled almost 9% in the past three sessions, including 2.75% before the fiscal briefing on October 12. China's stimulus and hints of more has seen the yuan's relationship to the yen and US yields slacken a bit but may still be potential into the CNH7.1150-CNH7.1250 area. 

UK: It is an important week for UK data. The two data points officials seem to put the most weight on draw market interest as well. The first, on October 15, is the labor market update. It seems that to many central bank officials the fact that UK payrolls have fallen by 24.5k through August (compared with an increase of 271k in the first eight months of 2023) is somewhat less important that the still firm average weekly earnings (5.1% three-months year-over-year, excluding bonus payments. Higher wages, so the conventional argument goes, is key to the sticky services inflation. Still, earnings are expected to have slowed in August and job growth slowed, even though we now know that economy expanded by 0.2% in August. The September CPI will be reported on October 16. Services inflation rose 5.6% in the year through August. In August 2023, services inflation was 6.8%. A 0.1% increase in the headline CPI, which is the median forecast in Bloomberg's survey, would allow the year-over-year rate to ease to 1.9% from 2.2% in August. However, this may prove the low point for the next couple of months, given the base effect (flat CPI in October 2023 and -0.2% in November). At the end of the week, the UK reports September retail sales. They likely slowed after August's 1.1% rise excluding gasoline/diesel. The market remains confident (90%+) of a BOE rate cut next month and leans (~55%) toward a December cut as well. 

Sterling fell almost 4.2-cents from the late September peak (~$1.3435) to the October 10 low (~$1.3020). It found bids ahead of $1.3000 but the upside has yet to prove convincing. It must resurface above around $1.3120 to boost the chances a low is indeed in place. The momentum indicators are oversold. Be on the lookout for a reversal pattern. That said, one more leg down cannot be entirely ruled out, of course, and a break of $1.30 could trigger another quick half-cent drop as stops are triggered. 

Canada: Neither the first drop in Canada's unemployment rate nor the 112k surge of full-time jobs, the most since May 2022, prevented the Canadian dollar from extending its losses before the weekend for the eighth consecutive session. The September CPI is the last important data point before the Bank of Canada meeting on October 23. There is little doubt that the central bank will deliver its fourth cut in the cycle that began in June. The issue is whether it can accelerate the pace by delivering a 50 bp cut. Expectations for a 50 bp cut peaked on September 27, with an 80% chance. The odds slipped but were little changed after the employment data, and if anything, slightly more in favor of a 50 bp move. The swaps market has nearly 72 bp of cuts over the two meetings in Q4 discounted after increasing for the past four sessions. CPI fell 0.1% in September 2023 and is expected to have fallen by 0.2% last month, which will allow the year-over-year rate to slip below 2.0%. Canada's inflation fell sharply in recent months. Consider it was at 2.9% year-over-year in January, and still there in May. It fell to 2.0% in August. In the three months through August, Canada's CPI rose at an annualized pace of less than 0.5%. In the last four months of 2023, Canada's CPI was flat. However, core inflation is given more weight by the central bank. The year-over-year core median and trim measures have eased by 0.3%-0.4% over the past three months to 2.3%-2.4% but are expected to have steadied last month.

The Canadian dollar was the worst performing G10 currency last week, falling 1.35% against the US dollar. The New Zealand dollar the second worst performer in the G10. It rose ahead of the weekend, but lost a net 0.75% last week, which featured the Reserve Bank of New Zealand becoming the second G10 country to cut its target rate by 50 bp. There seems little to deter a test on CAD1.3800. Still, the move seems exaggerated. The momentum indicators are stretched, and the greenback settled above the upper Bollinger Band for the third consecutive session before the weekend. A break of the CAD1.3680-CAD1.3700 area may suggest a top is being formed. 

Australia

The market continues to resist the clear signal by the central bank that a rate cut this year is unlikely. The futures market has a 50% chance of cut still discounted, down from nearly 75% as recently as October 1. The strength of demand, which the RBA has cited, is partly a reflection of the resilience of the labor market. The September report will be released early on October 17. Through August, 311k jobs were created (314k in the first eight months of 2023). Full-time job creation has been even faster than last year (~242k vs.182k). Despite the healthy job growth, the unemployment rate has edged higher (4.2% in July and August), as the participation rate increased from 66.6% in January to 67.1% in August. After the jobs report, the next important report ahead of the RBA meeting on November 5 is the quarterly CPI (October 30). A reversal of the gain in Q2 (3.8% from 3.6%) appears likely.

The Australian dollar held support at $0.6700 on October 10 and recovered to a little more than $0.6760 ahead of the weekend and China's "briefing" on October 12. The momentum indicators are stretch but a break of $0.6700 could see a push toward $0.6625-$0.6650. Still, it holds, a move above $0.6775 would be constructive, and stronger resistance may be offered by the $0.6800-$0.6815 band. 

Mexico:  Mexico has a light economic schedule in the coming days. That underscores the importance of international considerations. As an emerging market currency that trades 24 hours a day, the peso sometimes is used as a proxy for other less liquid emerging market currency. The peso is also sensitive to the risk environment. Using the S&P 500 as a proxy, the rolling 60-day correlation is near 0.50. the exchange rate is also often sensitive to oil prices (~0.35). Banxico meets next on November 17. The swaps market has about 35 bp of cuts discounted before the end of year, down from 45 bp before the US employment data. The combination of the lower inflation and weaker industrial production figures, coupled with the relative stability of the peso, may encourage the central bank to cut rates in November, especially if the Fed does. 

The US dollar held above the low it set on October 4 US employment report near MXN19.11. The greenback set higher highs each day last week until Friday. The peak on Thursday, slightly below MXN19.62, was below the previous week's high(~MXN19.83), while the pre-weekend low was near MXN19.30. Initial support is near MXN19.20. Meanwhile, concerns about Brazil's fiscal policy sent the real to a one-month low before the weekend. On Monday, the greenback held above the BRL5.40 support and recovered to test the upper end of the recent range near BRL5.60 Wednesday and Thursday. It briefly traded above BRL5.65 ahead for the weekend. President Lula called for bigger tax exemptions beyond his current proposal of BRL5000. Many critics fears a more populist agenda, which means more debt. Last month the US dollar peaked a little below BRL5.68. The three-year high set early August was near BRL5.8550.