Drivers for the Week Ahead

  • The rise in US rates continues to be the main driver for global markets
  • Markets will be particularly sensitive to US September PPI Wednesday and CPI Thursday
  • Fed speakers are numerous this week
  • Italy remains in focus after the European Commission informally rejected Italy’s draft budget late Friday
  • Markets have turned a bit more positive on a Brexit compromise after EU official comments last week
  • China returned after a week-long holiday and the PBOC promptly cut reserve requirements for commercial banks
  • Peru and Singapore central banks will meet this week

The dollar is mostly firmer against the majors as the new week begins. The yen and Antipodeans are outperforming, while the Loonie and Stockie are underperforming. EM currencies are mostly weaker. MYR and PHP are outperforming, while ZAR and CNY are underperforming. MSCI Asia Pacific ex-Japan was down 1.2%, with Japan markets closed for holiday. MSCI EM is down 1% so far today and trading at new cycle lows, with the Shanghai Composite down 3.7% upon reopening after a weeklong holiday. Euro Stoxx 600 is down 0.6% near midday, while US futures are pointing to a lower open. The US cash bond markets are closed today. Commodity prices are mostly lower, with Brent oil down 1.2%, copper down 0.3%, and gold down 0.8%.

The rise in US rates continues to be the main driver for global markets. Indeed, the impact has spread from the rates markets to the equity markets. This makes sense for several reasons. First, markets are coming to grips with a Fed that’s sounding more confident than ever in hiking rates (see our piece last week “Powell and Brainard Suggest Markets Underestimating Fed Hikes“). Second, high stock valuations were often justified by an unrealistic bet on low interest rates persisting. Those assumptions are now being challenged.

The equity market losses were widespread last week, with losses carrying over to this week. Last week saw the S&P 500 fall 1% and the NASDAQ by over 3%. Elsewhere, Euro Stoxx 600 fell nearly 2%, with Germany’s DAX and the UKs FTSE-100 both falling 2.6%. Hong Kong’s Hang Seng fell 4% last week, and mainland China’s markets are playing catchup today with a nearly 4% drop in the Shanghai Composite. All in all, MSCI EM fell 4.5% last week while MSCI DM fell nearly 2%. Both are down today with MSCI EM trading at a new cycle low near 991.

The US 10-year yield traded near 3.25% Friday, while the 2-year traded near 2.90%. Both are cycle highs. Note that the cash bond markets are closed today due to the US holiday. Bloomberg WIRP sees a 76% chance of a rate hike in December. Most importantly, the Fed Funds futures strip shows the market is finally starting to price in a third hike in 2019. While the Fed’s Dot Plot has shown three for quite some time, the markets are only starting to believe them. This is dollar-positive, to state the obvious.

Markets will be particularly sensitive to US September PPI Wednesday and CPI Thursday. Headline PPI inflation is seen easing to 2.7% y/y from 2.8% in August, while core is seen accelerating to 2.6% y/y from 2.3% in August. Headline CPI inflation is seen easing to 2.4% y/y from 2.7% in August, while core is seen accelerating to 2.3% y/y from 2.2% in August. Import and export prices data may be of some interest Friday but are unlikely to steal much thunder from PPI and CPI.

Fed speakers are numerous this week. They include Bullard today, followed by Williams, Kaplan, and Harker on Tuesday, then by Williams, Evans, and Bostic on Wednesday. No officials speak on Thursday, but Friday sees Evans, Bostic, and Quarles speak.

Italy remains in focus after the European Commission informally rejected Italy’s draft budget late Friday. In a letter to Finance Minister Tria, EU Commissioners wrote that “Italy’s revised budgetary targets appear prima facie to point to a significant deviation from the fiscal path” commonly agreed to by EU governments. Italy still needs to officially submit the draft budget to the European Commission by October 15, but these comments warn of conflict ahead.

UK reports August trade, IP, and monthly GDP Wednesday. As the macro data has come in firm recently, markets have fine-tuned their BOE expectations. Short sterling contracts have seen firmer implied yields since mid-August. Another hike has been fully priced in by March, with the next one priced for September. The expected rate path has steepened a bit, though we note that the next hike isn’t fully priced in until September 2020.

Markets have turned a bit more positive on a Brexit compromise after EU official comments last week. EU will reportedly offer a “super-charged” free trade deal to the UK. In return, it appears that the EU will not meet May’s demand for “frictionless trade.” At first blush, it would appear that the absence of “frictionless trade” means some sort of border checks within Ireland. That has proven to be a deal-breaker for May domestically, and so we remain skeptical that a deal will be that easy.

That said, UK press is reporting that a group of Tory Brexiteers have proposed allowing EU officials to be stationed at UK ports. While not exactly “frictionless,” this sort of compromise would avoid the hard border issue. UK Brexit Secretary will travel to Brussels this week to ffer a new deal while EU-27 ambassadors meet Wednesday ahead of a full EU summit next week. Stay tuned.

The rates story continues to support the dollar. DXY is on track to test the October high near 96.12 and then the August high near 97. We think the Italian drama will continue to weigh on the euro, with the $1.13 low from August likely to be tested in the coming weeks. Sterling is likely to remain very volatile and headline-driven to due Brexit. The yen is outperforming and a break below the 112.50 area would warn of a deeper correction in USD/JPY.

China returned after a week-long holiday and the PBOC promptly cut reserve requirements for commercial banks. PMI survey data released before the holiday pointed to further weakness in the economy ahead, and so the 100 bp cut should not be surprising. It is the fourth cut this year. This latest move is estimated to free up CNY1.2 trln, with a portion to be used to repay maturing funding facilities.

China reported September foreign reserves over the weekend at $3.087 trln vs. $3.105 trln expected. Money and new loan data could be reported this week, but no date has been set. September trade will be reported Friday, with exports expected to rise 8.7% y/y and imports by 14.5% y/y.

China’s relations with the US are likely to remain frosty after news last week that China used computer chips to hack into the servers of major US companies. US officials have been unusually subdued in discussing the hack, but it’s safe to assume that tempers are running high.

Brazil held the first round of its elections Sunday. Whilst Bolsonaro did not win enough to avoid a second-round vote, his margin of victory over Haddad was so large (46.2% to 29.1%) that most observers see him as the next president. The second-round vote will be held on October 28. A lot of good news has already been priced into Brazilian assets, and so we warn of potential “buy the rumor, sell the fact” reaction this week.

Elsewhere in EM, Peru and Singapore central banks will meet this week. While both are expected to remain on hold, Peru is likely to start hiking in Q1 and MAS is seen pausing after tightening back in April. We believe that most EM central banks will either start or continue tightening cycles in the coming months even as US rates keep rising. We believe the global backdrop for EM remains negative. With MSCI EM breaking below 1000, the next targets are the May 2017 low near 973 and then the April 2017 low near 951.