Drivers for the Week Ahead

  • The US mid-term elections will be held Tuesday
  • The two-day FOMC meeting ends with a decision Thursday
  • The US 10-year yield rose to trade near 3.22% Friday
  • China continues its data deluge; President Xi appears to be taking a hardline approach
  • RBA meets Tuesday and RBNZ meets Thursday; neither are expected to move on rates
  • EM FX got some traction last week as the dollar rally stalled but has come under pressure again this week

The dollar is mostly firmer against the majors as the new week begins.  Sterling and Loonie are outperforming, while Stockie and Swissie are underperforming.  EM currencies are mostly weaker.  PHP and RUB are outperforming, while INR and ZAR are underperforming.  MSCI Asia Pacific was down 1.2%, with the Nikkei falling 1.6%.  MSCI EM is down 0.8% so far today, with the Shanghai Composite falling 0.4%.  Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a lower open.  The US 10-year yield is down 1 bp at 3.20%.  Commodity prices are mostly lower, with Brent oil down 0.3%, copper down 0.9%, and gold down 0.1%.

The US mid-term elections will be held Tuesday.  According to the popular 538 Website, the Democrats have a 6 in 7 (85.2%) chance of winning control of the House of Representatives.  On the other hand, the Republicans have a 5 in 6 (84.2%) chance of keeping control of the Senate.  A split congress seems to be the base case that markets are working with right now.

Unlikely outcomes in recent political events (Brexit, 2016 US elections) have led some critics to claim that polls are somehow “wrong.”  We remind our readers that polls ultimately reflect probabilities.  So-called tail risk is present everywhere, and one can never rule out a “tail event.”

That said, we think a split Congress is the favored outcome for markets.  In some ways, the economic status quo would continue (tax cuts are retained) but having one Democratic chamber would allow for some checks and balances on the Executive branch.  The Fed will feel comfortable continuing the tightening cycle, while another round of tax cuts becomes more unlikely.  We will explore this theme in a longer MarketView piece later today.

The two-day FOMC meeting ends with a decision Thursday.  There is no press conference after this meeting and there will be no new forecasts or dot plots.  Note that this will be the last FOMC meeting with no accompanying press conference.  The December meeting will have one, and then every FOMC meeting will be followed by one starting in 2019.

We expect the FOMC to paint a fairly upbeat picture.  That is, the economy remains robust and price pressures are starting to rise.  Of course, it will likely note downside risks from persistent trade tensions.  We would be surprised if the Fed makes any mention of recent equity market volatility, as that is simply not in its purview right now.  Bottom line:  The Fed is unlikely to dissuade markets from expecting another 25 bp hike in December.

Because of the press embargo, no Fed officials speak ahead of the FOMC decision.  Afterwards, Quarles speaks Friday.  Ahead of the FOMC decision, the US reports October ISM non-manufacturing PMI Monday and September JOLTS data Tuesday.  After the FOMC, the US reports October PPI Friday.  The October jobs data is likely to result in firm US data last month.  Auto sales reported late last week may be a harbinger of strong overall consumption in Q4.

The US 10-year yield rose to trade near 3.22% Friday.  This was the highest since October 10 and is just below the cycle high near 3.26% from October 9.  It has since eased back to 3.20% today.  Likewise, the US 2-year yield traded as high as 2.92% Friday, a new cycle high.  If the recent rise in US yields can be sustained, then the dollar should extend its recovery.

The euro bounce ran out of steam near $1.1460 last week.  This was an important chart point, representing the 50% retracement objective of the euro’s October drop.  The reversal Friday was helped by reports that the ECB was considering another TLTRO.  After the report, ECB officials have said that a decision would not be made at the December meeting, but did not deny the substance of the story.

It may seem counter-intuitive for the ECB to consider another TLTRO even as it is ending QE and contemplating a rate hike after next summer.  However, the ECB seems to be acknowledging that peripheral banks (especially in Italy) may not be strong enough to deal with the end of easy money without some extra help.  At the margin, the ECB’s apparent cautiousness in fully normalizing policy strikes us as being euro-negative.

The UK reported October services and composite PMI readings earlier today.  Both were weaker than expected at 52.2 and 52.1, respectively.  The UK then reports September trade, IP, construction output, and Q3 GDP Friday.  The Bank of England sounded upbeat at its meeting last week, whilst cautioning about the negative risks that would come from a no -deal Brexit.  We do not think a cooperative Brexit deal would suddenly push the BOE into a more hawkish stance, and we instead favor the very modest rate path that’s priced into short sterling futures.

China continues its data deluge.  China reported a Q3 current account surplus of only $16 bln earlier today.  The surplus is expected to narrow to around 0.7% of GDP this year from 1.3% in 2017, which is a major reason why the US cannot really justify naming China a currency manipulator.  October foreign reserves will be reported Wednesday.  Here too, foreign reserves have been falling this year, making a manipulator label hard to justify.

China’s CPI and PPI will be reported Friday.  At this point, it’s clear that policymakers are more concerned about supporting growth than fighting inflation.  Trade data will be reported Thursday.

President Xi appears to be taking a hardline approach ahead of planned talks with President Trump at the G20 meeting.  Xi denounced “beggar-thy-neighbor” trade policies and denounced “law of the jungle” actions.  Xi announced further cuts to its import taxes but did not announce any more stimulus measures.  After Kudlow walked back Trump’s optimistic take on US-China relations last week, it seems that markets should not get too optimistic about a breakthrough anytime soon.

Reserve Bank of Australia meets Tuesday and is widely expected to keep rates steady at 1.5%.  Australia just reported soft CPI data for Q3, with headline inflation easing to 1.9% y/y from 2.1% in Q2.  The trimmed mean measure remained steady at 1.8% y/y after the Q2 reading was revised down from 1.9% previously.  Markets do not expect the first rate hike until late next year.

Reserve Bank of New Zealand meets Thursday (Wednesday afternoon during North American hours) and is widely expected to keep rates steady at 1.75%.  While headline inflation picked up to 1.9% y/y in Q3 from 1.5% in Q2, the central bank has expressed little concern.  Consumer confidence fell to a 3-year low in October and supports the RBNZ’s cautious stance.  Here too, markets do not expect the first rate hike until late next year.

EM FX got some traction last week as the dollar rally stalled but has come under pressure again this week.  Event risk remains high in many EM countries, notably Brazil, Mexico, South Africa, and Turkey.  The FOMC meeting this week is widely expected to see no action, but the Fed should signal that a December hike is on track.  As it is, US yields are marching higher again.  We believe the global backdrop for EM remains negative.  Peru and Poland central banks meet this week, with no changes expected.