Drivers for the Week Ahead

  • With US yields backing off last week, the dollar rally has been put on ice
  • US reports September retail sales today; FOMC minutes will be released Wednesday
  • The UK has a heavy data week; all eyes are on Brexit talks
  • China data deluge begins; US Treasury releases its semiannual FX report to Congress
  • Central banks of Hungary, Korea, and Chile meet this week

The dollar is mostly softer against the majors as pressure on equity markets resumes.  Swissie and yen are outperforming, while sterling and Stockie are underperforming.  EM currencies are mixed.  TRY and RUB are outperforming, while INR and KRW are underperforming.  MSCI Asia Pacific was down 1.1%, with the Nikkei falling 1.9%.  MSCI EM is down nearly 1% so far today, with the Shanghai Composite falling 1.5%.  Euro Stoxx 600 is down 0.1% near midday, while US futures are pointing to a lower open.  The US 10-year yield is down 1 bp at 3.15%.  Commodity prices are mostly higher, with Brent oil up 1.1%, copper up 0.3%, and gold up 1.1%.

With US yields backing off last week, the dollar rally has been put on ice.  Until the US 10-year yield makes a decisive break above 3.25% to the next trading range, we fear the greenback may see some further near-term losses in consolidative trade.  At the same time, the equity outlook remains cloudy.  Yes, equities staged a nice rebound on Friday but are back in the red today.

US reports September retail sales today.  Headline sales are expected to rise 0.6% m/m vs. 0.1% in August, while ex-autos are expected to rise 0.4% vs. 0.3% in August.  Lastly, the so-called control group used for GDP calculations is expected to rise 0.4% vs. 0.1% in August.  Auto sales were stronger than expected last month at a 17.4 mln annualized rate, so there may be some upside risks.

Weekly initial jobless claims for the BLS survey week will be reported Thursday.  Claims remain near multi-year lows, which made the September NFP gain of only 134k even more disappointing.  However, Hurricane Florence distorted the data and so the October reading takes on more significance.

We reiterate our belief that an equity market selloff will not prevent the Fed from hiking again in December.  Its twin mandates are clear, but there is some debate about the unofficial third mandate of maintaining financial stability.  The Fed’s job is not to support the equity market.  However, it would likely act if an equity market meltdown posed systemic risks or was part of a budding financial crisis.  We are not there yet.

FOMC minutes will be released Wednesday.  We do not expect much new news from the minutes, as the Fed has been quite clear in its confidence that further tightening is warranted.  According to Bloomberg’s WIRP, the market sees a 77% chance of a December hike.   Whilst down from 81% last Tuesday, it is up from the 72% low recorded near mid-week.  The Fed’s Daly speaks Tuesday, Brainard Wednesday, Bullard and Quarles Thursday, Bostic and Kaplan Friday, and finally Bostic again Saturday.

The Italian budget goes to the EU this week.  After critical EU comments on the draft, this will be their first look at Italy’s plan.  Polls show increased popular support for both Five Star Movement and League after the budget drama, and so the government will no doubt dig in its heels with regards to EU criticism of its fiscal policy.  The risks of conflict between Italy and the EU remain very high, and that should be reflected in higher Italian yields and spreads to Germany.  This is typically euro-negative.

The UK has a heavy data week.  It first reports labor market data Tuesday, followed by September CPI data Wednesday and retail sales Thursday.  Short sterling futures implied yields have backed modestly in recent days.  They now show the market is fully pricing in the next 25 bp hike by June and the one after by March 2020.  We think this trajectory assume some sort of Brexit compromise is reached.  To us, a no deal hard Brexit poses downside risks to the economy.

That said, all eyes will likely be on Brexit negotiations rather than the data.  Talks were reportedly suspended over the weekend when it became clear that differences could not be mended ahead of today’s deadline for the EU meeting on Wednesday.  Other reports suggest that if enough progress has not been made this week, the November summit will be turned into a no-deal summit.  Markets had become increasingly optimistic on a deal, so stay tuned.

One compromise that was floated last week called for extending the 21-month grace period.  Optimists say this would make the Irish backstop less likely to be invoked, but other reports suggest an extension would face strong opposition from the Democratic Unionist Party and would lead to some UK cabinet resignations.  It seems that a deal had been shaping up over the weekend but that Brexit Secretary Raab could not accept any deal that suggested an open-ended timeframe to the Irish backstop.

Japan will report some key data this week.  September trade will be reported Thursday, with exports expected to rise 2.3% y/y and imports by 13.7% y/y, both slowing from August.  National CPI will be reported Friday and will likely garner the most attention.  Headline inflation is seen steady at 1.3%, while ex-fresh food is expected to rise a tick to 1.0% y/y.

BOJ Governor Kuroda said over the weekend that when it is finally ready to exit monetary stimulus, the BOJ will signal it with a change in the target rates under its Yield Curve Control program.  He added that the market should no longer focus on the amount of bonds it buys.  There has been lots of speculation on how the BOJ will exit, though no one really expects it until 2020 at the earliest.  Kuroda added that continued wage gains are critical for meeting the 2% inflation target.

The China data deluge takes place this week.  September money and loan data will be reported this week, but no date has been set.  CPI and PPI will be reported Tuesday, with CPI expected to rise 2.5% y/y and PPI expected to rise 3.6% y/y.  Q3 GDP and September retail sales and IP will be reported Friday, with data expected to show modest slowing.

More importantly, the US Treasury releases its semiannual FX report to Congress this week.  There has been intense speculation that it will name China as a currency manipulator, even though reports suggest Treasury staff have recommended against it to Secretary Mnuchin.  The last country to be named was China back in 1994, which was right after the big yuan devaluation that January.  Note that in its April report, Treasury said it may expand the number of countries it examines from 13 to 20.

Central banks of Hungary, Korea, and Chile meet this week.  Hungary is widely expected to stand pat.  However, markets are evenly split between no hike and a 25 bp hike for both Korea and Chile.  We lean towards no hike from either this week.  We have been surprised by the resilience in EM this past week, but do not think it can be sustained for long as the global backdrop remains EM-negative.