- US data suggest the economy has borne the record storms and California fire fairly well
- A court ruling disallows Australian’s Deputy Prime Minister from being a member of parliament
- Spanish stocks and bonds are underperforming today as the Catalan-Madrid confrontation intensified
- EM FX remains under pressure
- Central Bank of Russia is expected to cut rates 25 bp to 8.25%; Colombia central bank is expected to keep rates steady at 5.25%
The dollar is mostly firmer against the majors as the week winds down. Kiwi and yen are outperforming, while sterling and Swissie are underperforming. EM currencies are mostly weaker. ZAR and MXN are outperforming, while KRW and RUB are underperforming. MSCI Asia Pacific was up 0.4%, with the Nikkei rising 1.2%. MSCI EM is up 0.1%, with the Shanghai Composite rising 0.3%. Euro Stoxx 600 is up 0.5% near midday, while S&P futures are pointing to a higher open. The 10-year US yield is down 1 bp at 2.45%. Commodity prices are mostly lower, with oil down 0.3%, copper down 1.5%, and gold up 0.1%.
This has been a good week for the US dollar. The Dollar Index’s 1.25% gain this week is the largest of the year. The drivers are two-fold: positive developments in the US and negative developments abroad.
The positive developments in the US include growing acceptance that the Fed will raise rates in December and that there will be more rate hikes next year. The Fed says three. The market now accepts at least one hike and has begun factoring in another. Also, the necessary steps toward tax reform have been taken. The first important step was the passage of the FY18 budget. The House passed the Senate version. The next step will come next week when the Chair of the House Ways and Means Committee releases his tax reform plan. It will then be marked up in committee.
Meanwhile, the buzz is that it is down to Powell and Taylor for Fed appointments. We think there is a reasonable chance that both are appointed. In any event, our general view is that in normal times, there is a large technocratic function rather ideological. The chief difference may lie in how the individuals respond to a crisis.
The FOMC meeting next week will be the first that the new governor Quarles participates. Reports of a longstanding personal rivalry between Quarles and Warsh may help explain why Warsh’s prospects have gradually dimmed. We estimate that fair value for the December Fed funds, assuming no chance of a hike next week, is 1.295%. The implied yield currently is 1.275%.
In addition, the US data suggest the economy has borne the record storms and California fire fairly well. Corporate earnings have been strong. Today, the first look at Q3 GDP will be reported. It is unlikely to match the 3.1% annualized pace in Q2, but will still be well above trend, which is seen a little below 2%. The composition of the growth may be a bit disappointing. It appears that consumption slowed but inventory growth accelerated. We sense that 1) investors may put more weight on GDP than the Fed and 2) officials may put more emphasis on real final domestic demand–excludes inventory and trade–as signals for the domestic growth impulses.
Looking further afield, at the end of next week, the US will report October employment figures. Non-farm payrolls are expected to jump by more than 300k as they bounce back from a storm-inflicted decline in September.
Developments abroad also helped the dollar. The ECB’s open-ended asset purchases with dovish forward guidance has encouraged the market to push the first rate hike further out. Draghi’s push back against tapering is not simply a game of semantics. The asset purchases are only one element of its extraordinary monetary policy. Other components include the full allotment of the fixed rate repo, the negative deposit rate, and the TLTROs. The only thing that is being adjusted is the asset purchases. Monetary policy is not being tapered. The asset purchase component is being re-scaled.
Divergence is very much intact. Starting this month through September 2018, the ECB’s balance sheet will expand by 450 bln euros, while the Fed’s balance sheet will shrink by $300 bln. Conservatively, the Fed can raise interest rates two to four times before the ECB goes once.
It seems like a cascading effect is being seen. Emerging market currencies turned. The dollar-bloc currencies followed. The majors are participating. The euro has held below the neckline at $1.1660 that was violated yesterday for the first time since late July. The rise in the US 10-year yield to seven-month highs has pushed the dollar above JPY114.00. The yen has held up the best among the majors against the dollar this week, partly perhaps as short yen cross positions, against euro, sterling and the dollar-bloc have been bought back as those currencies were liquidated.
There are a few new developments today that are rivaling yesterday’s (ECB meeting, US tax reform prospects, and Fed appointment speculation) as talking points. First, a court ruling disallows Australian’s Deputy Prime Minister from being a member of parliament due to his New Zealand citizenship when he was elected. This is important because the government had a one-seat majority in parliament, and that was it. The market may not have needed a new excuse to take the Aussie lower after the Q2 CPI disappointed earlier this week. A close below $0.7640, the 50% retracement of this year’s advance, would point toward $0.7530 as the next target.
Second, Japan’s CPI was in line with expectations, with a 0.7% year-over-year increase in September, the same as in August. The core rate, which excludes fresh food, was identical. With the LDP victory last week, BOJ Kuroda’s chances of the second term appear to have risen according to surveys. The point is that as slow as the ECB’s exit strategy may be, the BOJ’s is even slower. We would say the same thing about the Swiss National Bank: it is a laggard. The US dollar is testing CHF1.00 for the first time in five months today, while the euro is consolidating its gains against the franc that carried it to the best levels since that fateful SNB decision in January 2015.
Third, Spanish stocks and bonds are underperforming today as the Catalan-Madrid confrontation intensified. There was a movement toward having new regional elections as a way to avoid the implementation of Article 155. However, there may have been some tactical miscues, but there was no guarantee, apparently. In any event, Puigdemont, after fanning the popular passions, was politically unable to back down. There seems to be a trilemma of sorts here. The solution to the crisis must be either on the regional level (with the secessionists backing down and perhaps being replaced), a national level (a crisis in Madrid, where the minority government collapses and seems unlikely), or on a constitutional level. The last also seems unlikely at this juncture.
Fourth, sterling is the weakest of the majors today, sliding 0.5%, which is the bulk of its loss for the week (~0.7%). It fell to $1.3070 in the European morning, its lowest level since October 9. It trended lower but lagged behind the euro’s slide yesterday. The idea was that the prospects for a BOE rate hike next week was lending it support. That may still be true, but there was a bit of catch-up today. There is also recognition that the BOE rate hike is unlikely to be the start of a normalization cycle, but rather a one-off adjustment, taking back the post-referendum cut.
EM FX remains under pressure. Worst EM currencies so far this quarter? TRY (-6.5%), MXN (-5%), ZAR (-4%), and BRL (-4%). These are all subject what we’ve identified as heightened political risks, and we don’t see much relief over the near-term. The fifth-worst is surprisingly COP (-2.5%). Surprising because we don’t see any specific factor behind its recent underperformance.
Central Bank of Russia is expected to cut rates 25 bp to 8.25%. A handful of analysts look for a 50 bp cut. Inflation was 3% y/y in September well below the 4% target. While a bigger move is possible, we think the bank will play it safe with a 25 bp cut and follow up with another cut at its next meeting December 15.
Colombia central bank is expected to keep rates steady at 5.25%. A small handful of analysts look for a 25 bp cut. The bank remained on hold in September as inflation ticked higher to 4% y/y. Official comments suggest this is just a pause in the cycle, but we think recent COP weakness could delay the next cut. The next meeting after this one is November 24. Timing of the next cut will be very dependent on data and COP.