- Investors continue to push equity markets to new highs on the assumption that the policy easing from the Fed could engineer a soft landing of the US economy. Next week’s data will be crucial to keep this narrative going.
- Under the surface, macro uncertainty has been volatility positive. Cross asset volatility related to the US election, upcoming central bank meetings, Chinese stimulus measures and the French budget has been keeping investors on their toes.
- The US election is 25 days away and Donald Trump has recently surged in both of the popular betting markets (Polymarket, PredictIt). While not the most important factor for markets, it is likely to have added to the spike in the dollar and yields.
- US headline inflation slowed less than expected and core inflation increased for the first time this year, showing how the disinflationary process is at danger to stall. However, it will likely not dent the prospects of a Fed rate cut in November.
- Some German data (retail sales, industrial production) surprised to the upside last month. However, the overall macro news flow remains dire and the French budget woes mean that a rate cut in both October and December remains our base case.
- With 10-year US Treasury yields back at August highs, the US dollar’s appeal is strengthening. The 120-day correlation between these two variables has never been so positive for so long, and it is also stretching to near its highest in years.
Global Macro
Record highs mask wall of worry
No landing equity positive. US equity markets reached their 44th record high this week. One reason for it: the no-landing scenario has been gaining traction in the United States. Economic momentum has turned north again, highlighted by the uptick of the surprise index into positive territory. Investors have reflected this narrative shift away from recessionary fears by pushing both the two- and ten-year Treasury yields beyond the 4% mark for the first time since early August.
Wall of worry. However, the wall of worry continues to trouble investors across the world. The 30-day implied volatility index (VIX) for the S&P 500 now incorporates the next US labor market report, presidential election and FOMC meeting and has risen well above its 2024 mean to 21.00. Markets have therefore started to incorporate the risks associated with the upcoming US election, which has raised hedging costs and FX price swings alike. Bond market volatility jumped to its highest level this year as investors prepare for the vastly different policy implications from the two Presidential candidates.
Incorporating election risks. The race between Trump and Harris has essentially become to close to call and polls and betting markets remain within the margin of error. Price swings going into the election on November 5th will remain a feature of markets as the fluctuation of the implied winning probabilities lead to constant repricing on markets. A lean towards Trump in the betting polls could benefit the US dollar, while a rise of Harris on betting markets could alleviate some pressure off EM FX.
Inflation out of the way. US core inflation jumped from 3.2% to 3.3%, recording its first annual increase since early last year. However, initial jobless claims surprised to the upside, coming in at 258k. This makes for a difficult mix for the Fed. However, another 25-basis point cut in November remains the base case with an 85% probability.
Global Macro
Macro points to more cuts from the ECB
Shunning France. The French equity benchmark has erased its year-to date gain as investors awaited changes to the government budget and an increase in taxes. This stands in stark contrast to the gains for the broader European and US indices of around 10% and 20%. Policy makers want to fill the €60 billion gap in the budget via 1) spending cuts, 2) temporary levies on some 440 companies with revenues of over €1 billion and other tax increases. Asset managers have shunned French sovereign debt for a while now. Risk averse Japanese investors sold the debt of Eurozone’s second-largest economy for four consecutive months, signaling a turn away from France. The risk premium on holding French government bonds (vs. German ones) remains near its highest level since 2012. This fiscal dilemma explains the underperformance of the CAC 40 as earnings estimates have fallen so far this year, compared to a slight rise for the DAX and broader STOXX 600.
ECB to cut rates next week. Traders are warming up to the idea that the European Central Bank might have to cut interest rates by 25 basis points at two consecutive meetings in October and December. This would push the deposit facility rate to 3%, down from the peak of 4%. The recent dovish tilt in policy pricing can be seen as a reaction to the continued weakness of the German economy and inflation slide to below 2% in most European countries. The prominent German ECB board member Isabel Schnabel dropped her hawkish stance some weeks ago and shifted her attention to the downside pressures on growth. As the labor market cools, so too will the pressure to ease policy continue to build. These downside pressures were acknowledged at the last meeting, looking at the minutes. The Governing Council raised the possibility of growth disappointing expectations.
Week ahead
More policy easing needed?
Volatility indicators have been on the rise recently, trying to incorporate the upcoming macro and political risk events. The data next week will likely show the need for continued policy easing as the weight of high interest rates continues to pressure the global economy. US retail sales, UK labor market data and inflation, and Eurozone industrial production will be front and center. On the monetary front, the European Central Bank is expected to cut interest rates for a third time this year.
US slowdown. US retail sales and industrial production for September will likely not stand in the way of a 25 basis point cut at the next Fed meeting in November. Sales likely increased by 0.1%, same as last month. Factory output was under pressure last month and could show some signs of weakening. Staying in North America, Canadian inflation could fall below the important 2% mark for the first time since early 2021. This should strengthen the Bank of Canada’s dovishness.
ECB cut. The European Central Bank is expected to cut interest rates by 25 basis points next week. The monetary authorities increased dovishness with the incoming data disappointments have paved the way for another easing in December, which would bring down the deposit rate to 3%.
UK disinflation. In the United Kingdom, wage growth probably continued slowing in the three months to August, coming down from 5.1% to 5.0%. Inflation should cool further in October, giving the Bank of England plenty of reason to ease policy in November. UK CPI likely fell to 1.8% on an annual basis, down from 2.2% in September.
FX Views
Limited catalysts to reverse dollar’s course
USD Overbought, but bullish drivers aplenty. Defying weak seasonal trends in October, the US dollar index has risen for nine days on the trot, its longest winning streak in over two years. With 10-year US Treasury yields back at August highs, the US dollar’s appeal is strengthening. The 120-day correlation between these two variables has never been so positive for so long, and it is also stretching to near its highest in years. Driving yields and the dollar higher are Fed rate expectations. In the wake of the strong US jobs report earlier this month, markets are pricing in 45bp of easing by year-end, (less than two 25bp reductions), versus 70bp at the start of the month. The dovish shift from other major central banks has also made their respective currencies less appealing relative to the buck. US economic momentum has turned north again too, highlighted by the uptick of the surprise index into positive territory. Thus, relative growth and yield differentials continue to support the dollar, whilst its safe haven allure and positive correlation with rising oil prices are yet more bullish drivers keeping USD risks skewed to the upside in the short term.
EUR Lower ahead of ECB. EUR/USD fell to two-month lows over the last week as markets looked ahead to the upcoming European Central Bank decision where markets see a 96% chance of 25-basis point cut. EUR/USD has fallen as much as 2.8% from its late-September highs. The euro has also notably fallen versus the Swiss franc and Canadian dollar during October, although it’s gained versus GBP, AUD and JPY. The market remains mostly cautious towards the euro with one-week risk reversals at their most negative since mid-July. That said, the EUR/USD rebounded from the $1.09 level – right at the key support at the 200-day moving average – with momentum measures also nearing oversold levels, so the potential for a rebound is building. Topside orders look to $1.1025 while downside orders will target $1.0910. Apart from the ECB, next week also brings German ZEW sentiment on Tuesday and final CPI numbers on Thursday.
GBP Stale week; tough month. Having appreciated against 70% of its global peers last month, the pound has only appreciated against 16% of its peers so far in October. Despite UK yields rising to their highest since July, sending the UK-German 2-year spread to its highest in over a year, GBP/EUR has slipped 0.7% MTD. Meanwhile, GBP/USD has fallen 2.4% in line with tumbling rate/swap differentials amidst the paring back of Fed easing bets. This highlights how sensitive/vulnerable sterling is to Fed rate expectations. Furthermore, the weaker cyclical context via moderating UK economic activity is weighing on the pound, whilst rising geopolitical uncertainty and oil prices is hurting it through the risk channel. With bullish GBP bets still overcrowded, the threat of a more dramatic sterling depreciation through a sharp unwinding of these positions, raises the prospect of GBP/USD sliding below $1.30. Having broken below its 50-day moving average this week for the first time since August, the next downside target could be the 100-day moving average located at $1.2941. The upcoming UK inflation report could be pivotal, especially if services inflation surprises lower – increasing the chance of two 25bps rate cuts by the BoE this year versus the total 37bps priced in at present.
CHF A safe bet for now. The 50-day moving average remains a hurdle to the upside for EUR/CHF. The currency pair remains trapped in a downward channel in place since May this year. The weakness of the euro is largely to blame, but the renewed strength of the Swiss franc since spring is clear to see across the board, with it appreciating against 80% of its peers over the past four months. The franc’s outlook is becoming more complex going into year-end though and bulls may need to be more selective after their narrative was revived this summer. Its safe haven appeal amidst heightened geopolitical risks, including tensions in the Middle East and the upcoming US election, should keep the franc supported against high-beta peers. Plus, the US is Switzerland’s top export destination at around 17% of its total, so a resilient US economy might also be a boon to the swissy through the trade channel. Nevertheless, the Swiss National Bank’s tolerance for further appreciation might wane amid disinflation, which could trigger more FX intervention over the coming months, limiting the franc’s upside potential.
CNY China MoF to detail fiscal policy shift amid economic headwinds. At a news conference organised by the State Council Information Office on Saturday, October 12, at 10:00, China’s Minister of Finance Lan Fo’An will provide an update on the enhancement of counter-cyclical fiscal policy adjustment and the promotion of high-quality economic growth. Securities Times reported from Beijing. Following the policy-driven pattern break and the positive US labour statistics, USD/CNH whipsaws. We consider the region 7.078-7.108 to be a crucial zone of bifurcation for the pair. The bullish CNH trend may be extended if it were possible to make a tactical recovery from that support and push back through the internal pattern trend line in 2023–2024. Future economic disclosures, especially those regarding the FX reserves, should be closely monitored by traders.
JPY Ex-BoJ official tips January rate hike as policy pivot looms. About six months after the rate increase in July, Eiji Maeda, the previous executive director in charge of BoJ monetary policy, said in January that there is the largest chance of an interest rate rise in January when the central bank presents its most recent economic estimates. The US presidential election in November, the trend in service pricing this fall, and the momentum leading up to the annual wage negotiations next year, he added, might cause the date of the raise to shift to December or March. At the meeting on October 31, Maeda said that there was “almost no chance” of a policy change. If they relocate, it would seem as if they do so every three months. With the Fed expected to ease over the next year, that may bode well for the Yen given the strong correlation, as the chart shows. After the US labour report, the USD/JPY pair continues to rise from critical support around 140 and develops what may be the right shoulder of the cycle-top pattern for 2023–2024. We anticipate that the rally would falter close to crucial resistance at 151. Traders need to keep an eye on PPIs, current accounts, and impending household expenditure.
CAD Oil helps, but greenback dominates. The Canadian dollar extended its October doldrums over the last week with the currency lower as the USD/CAD climbed to two-month highs. However, it wasn’t all bad for the CAD, with gains in other markets. The Canadian currency has gained versus the GBP, Japanese yen and Australian and NZ dollars over October. The CAD was helped by the surging crude oil price, which hit three-month highs over the last week as tensions grew in the Middle East. The USD/CAD gains, driven mostly by USD strength, have seen the pair move up towards the 1.3800 level that has been major resistance for the market over the last two years. Additionally, momentum indicators are stretched, with the relative strength index nearing the overnight level, creating the risk of a reversal lower in USD/CAD. Order levels for the week ahead are seen at 1.3790 to the topside and 1.3680 to the downside. Tuesday’s CPI release is next week’s highlight.
AUD RBA’s policy review: TFF lessons drive risk framework overhaul. Assistant Governor Christopher Kent said on Wednesday that, in light of the lessons from its term financing facility (TFF), the RBA would improve its evaluation of the risks associated with implementing unconventional monetary policy and possible exit routes. Although the RBA may utilise the TFF again in dire situations, its limitations have resulted in “material financial costs,” totalling AUD9 billion, according to Kent. He said, “A different calibration of the TFF, including deciding not to extend it in September 2020, could have resulted from a greater focus on potential upside economic outcomes.” Next year will see the release of the RBA’s framework for new monetary policy instruments. AUD/USD whipsaws back into the 2023–2024 region after its brief breakout effort last week. If the short-term support level between 0.6745 and 0.6771 is maintained, the pro-cyclical trend that is emerging may continue. Investors want to keep an eye on Westpac’s consumer sentiment and NAB’s business confidence.
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