- Strong corporate earnings briefly boosted stocks in the US last week. Markets were able to focus on actual earnings power over the economic data. Still, equity valuation remains linked to rate decisions of central banks and risk sentiments.
- Commodity currencies including CAD, AUD, and NZD outperformed as oil prices rose last week given tightening supply and uncertain demand. This was slightly mitigated by the news that the US would release more crude oil from the Strategic Petroleum Reserves.
- This week, markets are unlikely to see signs of a Fed pivot. A forecast on initial jobless claims expects a tight labor market, and a forecast on GDP suggests the US economy can handle a jumbo rate hike.
Data/Events Calendar Oct 24 – 28
Tuesday: US Consumer Confidence
Wednesday: Bank of Canada Interest Rate Decision
Thursday: ECB Interest Rate Decision; US GDP Growth Rate QoQ, Jobless Claims
The breakeven rate on inflation-protected bonds can be viewed as a reliable measure of inflation expectations for longer horizons than those measured by surveys. Current readings (see table at the bottom) show inflation is expected to cool towards central bank targets, which may be more a reflection of pessimism on future global economic growth.
Last Week's Range
EUR/USD 0.97-0.99 GBP/USD 1.11-1.14 USD/CAD 1.36-1.39 AUD/USD 0.62-0.64 USD/JPY 146.2-152 USD/CNH 7.19-7.28 USD/ILS 3.51-3.58 USD/MXN 19.9-20.2 USD/CHF 0.99-1.01 USD/INR 82-83.3 USD/BRL 5.14-5.3 USD/SGD 1.42-1.43 USD/DKK 7.53-7.66 USD/SEK 11-11.4 USD/NOK 10.5-10.7
Market Bias: Hawkish
- Industrial Production in September came in better than expected, hitting a new record high and providing relief to the economic slowdown.
- Worse-than-expected data from the US housing market is attributed to high mortgage rates. Housing starts dropped 8% to 1.4m. The mortgage application index fell 4.5% last week.
- The Fed meeting minutes indicated “inflation was declining more slowly than they had previously been anticipating” and the markets have entirely priced in a fourth consecutive 75-bps hike at the next Fed meeting in November. The terminal rate is projected to be 4.9%.
- Risk to current market bias: Continued weakness in housing and labor markets will weigh on the risk of recession and result in a less hawkish Fed.
Market Bias: Bearish
- The UK reported a higher-than-expected CPI, indicating inflation is not slowing down.
- Ongoing political volatility continued. Liz Truss announced her resignation as Prime Minister following seriously adverse reactions from financial markets. A leadership election will be completed within this week. The new chancellor is expected to outline steps to support the country’s fiscal sustainability after the policy U-turn. A lack of fiscal policy could further jeopardize economic growth.
- The BOE confirmed that it would begin its tightening program and sell gilts on 1 Nov to refocus on the inflation fight. Long-term bonds are excluded initially.
- Risk to current market bias: Market perceives positive impacts from the changes, and GBP recovers from current depressed levels.
Market Bias: Bearish
- EU inflation rose to 10% in September, implying that the ECB, the central bank the governs the European Union, will need to be hawkish and deliver a 75-bps rate hike this week as expected.
- Investors remained bearish on the eurozone’s long-term outlook despite gas prices dropping.
- Risk to current market bias: The European Commission proposed €40 billion in aid to help businesses and households as part of the energy package. EU member states have tagged €500 billion to cushion the impact of the energy crisis. The Cohesion Fund would also be used to support labor markets. Plus, positive news on energy supplies could provide a temporary lift on EUR.
Market Bias: Bearish
- Markets anticipate the Bank of Canada (BoC) to increase the interest rate by 50bp after implementing a 75bp rate hike previously. However, the Federal Reserve is expected to raise rates by 0.75% at both its November and December meetings.
- The BoC is expected to bring an earlier end to its rate hike cycle to reduce the recession risk thereby supporting a stronger US dollar.
- Despite expectations of a slowing global economy and a decrease in the consumption of oil, the price of a barrel of oil remains supported by planned output cuts by OPEC.
- Risk to current market bias: Canada’s headline CPI came in stronger than expected in September. A more hawkish tone from BoC might push the terminal rate expectations closer to the Fed’s 4.8%, resulting in a stronger CAD.
Chinese yuan (CNH/CNY)
Market Bias: Bearish
- There is no evidence of a changing direction for the Zero-COVID policy and housing market policies, the two major factors that are slowing down China’s economy.
- The capital outflow risk continues to increase as the policy divergence between China and other major economies is widening.
- Risk to current market bias: China is debating a reduction in COVID quarantine for inbound travelers. Potential relief on COVID restrictions could support RMB. According to Reuters, major state-owned banks in China swapped RMB for US dollars in the forwards market and sold those dollars in the spot market to stabilize RMB during the Communist Party Congress.
Market Bias: Bearish
- Japan's inflation reached 3%, exceeding the Bank of Japan's (BOJ) target of 2%, yet rate hikes are nowhere in sight suggesting the currency will continue to receive downward pressure from low interest rates.
- USD/JPY reached the key psychological level of 150, then 152 for the first time in 32 years, prompting the BOJ to intervene in currency markets by buying JPY. As with previous interventions, the initial impact was a success, as the currency appreciated to 146. However, there is no guarantee that the level will hold as intervention is generally a temporary and very expensive fix.
- Risk to current market bias: The BOJ wants to prevent the JPY from weakening rapidly. In August, Japan had $1.17 trillion in reserves, and the September intervention cost Japan $20 billion, according to the Washington Post. There is enough buffer for ongoing interventions.
Breakeven rate between standard government bonds vs inflation-protected bonds (%) Inflation Target (%) Current Inflation (%) 3Y 5Y 10Y US 2 8.2 2.61 2.6 2.46 UK 2 10.1 4.08 3.78 Germany 4.5 10 2.4 3.11 2.28 Canada 2 6.9 2.19 2.09 Japan 2 3 1.27 0.91
Source: Bloomberg: World Inflation Breakeven Rates
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