Drivers for the Week Ahead

  • The dollar is caught between safe-haven flows and the shift in market Fed expectations
  • Clarida speaks Tuesday while Powell speaks Wednesday; FOMC minutes will be released Thursday
  • The EU signed off on May’s Brexit deal at the weekend summit in Brussels
  • It’s clear that the Q3 slowdown is more than just a temporary phenomenon in the eurozone
  • Italy signaled some willingness to tweak its budget
  • Oil prices are likely to continue falling
  • It’s a quiet week for EM in terms of central bank meetings and data

The dollar is mostly weaker against the majors as the new week begins.  The Scandies are outperforming, while the yen and Swissie are underperforming.  EM currencies are mixed.  TRY and IDR are outperforming, while RUB and INR are underperforming.  MSCI Asia Pacific was up 0.5%, with the Nikkei up 0.8% after reopening from holiday.  MSCI EM is up 0.9% so far today, with the Shanghai Composite falling 0.1%.  Euro Stoxx 600 is up 1.1% near midday, while US futures are pointing to a higher open.  The US 10-year yield is up 2 bp at 3.06%.  Commodity prices are mostly higher, with Brent oil up 1.8%, copper up 0.1%, and gold up 0.3%.

The dollar is caught between safe-haven flows and the shift in market Fed expectations.  Risk-off sentiment continues to come in waves, hurting equities and EM assets and helping the dollar and yen.  On the other hand, the implied yield on the January 2020 Fed Funds futures contract remains pinned near 2.73%.  That suggests only one more hike is expected in 2019 after this December hike.  At some point, we believe markets will revert to a more hawkish take on the Fed, but it will take some time.

Fed Vice Chairman Clarida speaks Tuesday while Chairman Powell speaks Wednesday.  These two will be the most closely watched in light of their dovish comments earlier this month that significantly reset market Fed expectations.  Bostic, Evans, and George speak on a panel together Tuesday.  Evans speaks again Thursday, followed by Williams Friday.

FOMC minutes will be released Thursday.  We do not think the Fed has done anything to dissuade markets about a December hike.  Yet the adjustment in market expectations has taken place further out.  The implied yield on the January Fed Funds futures contract slumped to 2.715% on Friday, the lowest since September 6.

US reports revised Q3 GDP Wednesday, which is expected to tick up to 3.6% SAAR.  The Atlanta Fed’s GDPNow model is tracking 2.5% SAAR growth, down from 2.8% last week, while the NY Fed’s Nowcast model is tracking at 2.6% SAAR.  Sequentially speaking, growth has slowed from the 4.2% SAAR peak in Q2.  However, growth remains above trend.

US personal income and spending for November will be reported Thursday.  Included in that report is the core PCE deflator, which is expected to tick down to 1.9% y/y after spending several months at the Fed’s 2% target.  Chicago PMI for November will be reported Friday.

The EU signed off on May’s Brexit deal at the weekend summit in Brussels.  It must now be approved by the UK parliament and the EU made it clear that it is done talking. This is the deal that must be passed, or it becomes a no-deal Brexit in March.  No date has been set for the parliamentary vote, but May has promised a few weeks of campaigning followed by a vote before Christmas.

Most political analysts say the math does not favor May’s plan.  However, a lot can happen over the next few weeks and so we remain hopeful that it passes.  If it does not, then we would get the worst possible combination of no-deal Brexit and likely fresh elections that could bring Labour to power.  While sterling is seeing knee-jerk buying after the EU summit, we suspect gains will be limited ahead of the uncertain parliamentary vote.

Germany reports preliminary November CPI Thursday, followed by the eurozone reading Friday.  The former is seen falling to 2.3% y/y from 2.5% (2.4% EU harmonized) in October, while the latter is seen falling to 2.0% y/y from 2.2% in October.  German October retail sales will be reported Friday.

It’s clear that the Q3 slowdown is more than just a temporary phenomenon after weaker than expected eurozone flash November PMIs were reported last week.  Indeed, the record of the October ECB meeting seemed a bit more pessimistic than Draghi was.  Draghi speaks twice today in Brussels and then Thursday in Frankfurt.  The December 13 ECB meeting will be very important, as updated staff forecasts will be released and likely to set the tone for 2019.

Italy signaled some willingness to tweak its budget.  Officials will reportedly meet this week to discuss different scenarios for lowering the 2019 deficit target.  As a result, the 10-year spread to German has fallen to 287 bp from the 327 bp peak last week.  This has helped the euro recover a bit, but the saga is by no means over.

Japan reports a fair amount of data.  October retail sales will be reported Thursday.  Then October labor market data and IP as well as November Tokyo CPI will be reported Friday.  Real sector data are expected to remain firm, but Tokyo headline CPI is seen falling to 1.1% y/y from 1.5% in October.  Governor Kuroda made it clear last week that the BOJ is unlikely to remove stimulus until FY2021 at the earliest.

The yen is caught between conflicting forces.  It has benefitted from risk-off sentiment, but the BOJ’s ultra-dovish is working the other way.  For now, USD/JPY is caught in a narrow 112-114 range, but we suspect the pair will move higher as risk-off sentiment ebbs.

Oil prices are likely to continue falling.  This will likely be a topic at the G20 meeting that starts Friday.  With last week’s break of 60.55, Brent oil is headed towards the June 2017 low near 44.35.  WTI is leading this move, having already broken its 62% retracement of the 2017-2018 rally earlier last week.  It too is on track to test the June 2017 low near 42.05.  The currencies with the highest correlation to oil are CAD and COP, followed by NOK and then RUB.  MXN correlation is surprisingly low at -0.118 vs. WTI.

We fully expect Saudi Arabia to push through a significant cut in OPEC output next year in response to falling oil prices.  Oil got a brief reprieve last week when it announced plans to cut output by 1 mln bbl/day next year, but then the sell-off quickly resumed.  It appears that an even bigger cut will be needed.

Russia may face further sanctions as tensions with Ukraine mount.  Over the weekend, Russian fired on Ukrainian warships in the Kerch Strait near Crimea.   Russia claimed that the ships had violated its territorial waters.  However, the two had previously agreed on full access to that strait.  The UN Security Council will meet this week to discuss the situation.

It’s a quiet week for EM in terms of central bank meetings and data.  Most of the action will take place Friday, when Bank of Korea meets, and China reports official November PMIs.  BOK is expected to hike rates 25 bp to 1.75% but the market is split, and we favor no change.  China manufacturing PMI is expected to remain steady at 50.2, while non-manufacturing is expected to fall a tick to 53.8.  We see downside risks to China building, and so we expect further stimulus measures in the coming weeks.