Higher US Rates Extending the Dollar Rally

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  • Yesterday, reports suggesting that Trump was enthusiastic after meeting with Taylor may have prompted a reversal in the yields
  • The euro continues to be hampered by political concerns
  • UK reported September CPI; New Zealand reported Q3 CPI overnight
  • Singapore reported September trade data; the Mexico peso remains under pressure

The dollar is mostly firmer against the majors, supported by higher US rates.  Kiwi and yen are outperforming, while the euro and Scandies are underperforming.  EM currencies are mostly weaker.  PHP and HKD are outperforming, while ZAR and CNY are underperforming.  MSCI Asia Pacific was down 0.1%, with the Nikkei rising 0.4%.  MSCI EM is down 0.3%, with the Shanghai Composite falling 0.2%.  Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a lower open.  The 10-year US yield is up 1 bp at 2.31%.  Commodity prices are mixed, with oil up 0.4%, copper down 0.9%, and gold down 0.6%.

The market is fickle.  It has jumped from one candidate to another as the most likely Fed Chair.  Until his belated and mild criticism of the President dealing with race issues, economic adviser Cohn was regarded as the most likely successor to Yellen at the head of the Fed.  When Cohn fell out of favor, it was seen as a contest between Yellen and former Fed Governor Warsh.

Powell’s stock rose recently, and there have been reports that Treasury Secretary Mnuchin favors him.  Yellen has slipped in the betting markets, as president-as-disrupter has little time for tradition or the fact that Yellen has steered the Fed quite remarkably through tapering, rate hike and now balance sheet reduction with very little drama.

Yesterday, reports suggesting that Trump was enthusiastic after meeting with Taylor saw his stock rise in the betting websites and may have prompted a reversal in the yields.  The US 10-year yield closed higher, and the December futures contract surrendered the gains scored in the wake of the disappointing CPI report before the weekend.  The 2-10 curve did not change; yields rose nearly uniformly by three basis points.

We caution against reading too much into the process whereby the Trump meets the different candidates for the post that his staff have identified.  Also, although the Taylor rule would suggest higher rates may be appropriate, Taylor himself is opposed to blindly following any model.  The US-German 2-year spread is 227 bp today, the cycle high.

PredictIt has Powell as the most likely nominee, with a little more than a one-in-three chance.  A week ago, his chances were even-money.  The new new thing is that Taylor’s odds have improved to one-in-five from one-in-ten.  It is pretty much a dead heat between Taylor and Warsh, with Yellen in fourth place.

The euro continues to be hampered by political concerns.  Local press is reporting that the Spanish government is preparing to replace the top Catalan security officials.   This would be the first step in the Article 155 process.  Spanish official said that the application of Article 155 would be light at first.  Break below $1.1750 would set up a test of this month’s low near $1.1670.

UK reported September CPI.  Headline came in as expected 3.0% y/y, as did CPIH at 2.8% y/y.  This is the highest reading for headline inflation since April 2012, and will feed the notion that the BOE is close to starting the tightening cycle.  UK jobs and retail sales data tomorrow and Thursday will round out the macro picture.  Many economists still expect UK inflation to peak here in Q4, while the economy continues to gradually slow.

The next BOE policy meeting is November 2.  Bloomberg’s WIRP page puts the odds of a hike then at 84%.  However, we warn of potential disappointment and market positioning suggests the reaction may be dramatic to anything that would justify waiting an extra month before hiking rates.

New Zealand reported Q3 CPI overnight.  Inflation was 1.9% y/y vs. 1.8% expected, and up from 1.7% y/y in Q2.  Still, the RBNZ has made it clear that it is in no hurry to begin the tightening cycle.  The next policy meeting is November 9, and rates are likely to remain at 1.75%.

Singapore reported September trade data overnight.  NODX contracted -1.1% y/y vs. an expected gain of 12.7% and 17% in August.  Last week, the MAS tweaked its forward guidance to give it flexibility on policy.  At the same time, it highlighted slower growth and low price pressures in 2018.  April tightening is possible, but will depend on how Q4 and Q1 data come in.  If downside risks persist, the MAS will delay a move.

The Mexico peso remains under pressure.  It’s worth noting that despite steady gains this past week, USD/MXN has only recouped about a third of this year’s losses.  Retracement objectives from the January-July drop come in near 19.2030 (38%), 19.7445 (50%), and 20.2860 (62%).  While 22 seemed excessively pessimistic, we think 17.45 was excessively optimistic.  The truth lies somewhere in between, perhaps around 20.