The dollar gained against all G10 currencies last week, but higher US interest rates didn’t drive it. Instead, the 10-year Treasury yield fell for the first time in five weeks, and the two-year yield held steady. The real story was falling rates in other countries, leading to a widening US rate advantage. The US two-year yield premium over Germany rose for the fourth straight week to its highest level since June, while the premium over Canada reached levels not seen since 1997. Meanwhile, the US yield discount to the UK narrowed significantly.
Political factors are also impacting markets, with the US election adding uncertainty. Volatility in capital markets often equals risk; in the political sphere, that risk is tied to credibility and capability. Concerns are centring on a potential Trump victory, with fears that his aggressive tariff plans could disrupt global trade, negatively impacting US trading partners.
Four key developments stand out: potential rate cuts from China and the Bank of Canada, insights from the Fed’s Beige Book, and preliminary October PMI data.
U.S.A.
Surveys vs. Late Q3 Reports
In the days ahead, two main types of economic data will be released: October survey data, including various Federal Reserve surveys and preliminary PMI, and some late Q3 real sector data, such as new and existing home sales, as well as durable goods and factory orders. The initial Q3 GDP estimate is set for October 30, but this week’s data is unlikely to significantly shift expectations. Current forecasts place Q3 GDP at 3.4% according to the Atlanta Fed and 3% according to the New York Fed, aligning with Bloomberg’s median estimate.
Fed’s Beige Book Gains Importance
The most crucial report next week is likely to be the Fed’s Beige Book. Unlike previous Fed chairs who downplayed its significance, Chair Powell has used it to justify policy decisions, especially at key economic turning points. He has emphasized the Beige Book’s insights alongside the Fed’s “dot plot” projections. For example, he referenced it in September to support a half-point rate cut that marked the start of the current easing cycle. As we look ahead, it seems the market may have overestimated the impact of the September employment report, with early forecasts for October nonfarm payrolls set at around 130,000.
Recent Rally and Future Support
The Dollar Index’s recent upward correction has been stronger than expected, driven by the market’s alignment with the Fed’s guidance, which led to a rebound in short-term US rates. This marks the fourth rally this year. The first rally, lasting about six weeks early in the year, saw the Index gain nearly 4%. The second, from early March to mid-April, was slightly above 4%. The third, in June, resulted in a rise of just over 2%. The current rally began in late September, reaching about 3.7% growth before stopping just short of the 61.8% retracement from the year’s high recorded in mid-April, near 104.10. Momentum indicators suggest a potential downturn soon, with initial support levels around 103.00 and then 102.45.
Key Points:
- Upcoming data includes October survey results and late Q3 economic reports.
- Fed’s Beige Book is becoming more significant under Chair Powell’s guidance.
- The Dollar Index has experienced four notable rallies this year, with the current one potentially nearing its peak.
- Short-term support for the Dollar Index may be found near 103.00 and 102.45.
Australia
September Jobs Report Reduces Rate Cut Expectations
The stronger-than-expected September employment report has diminished the likelihood of an Australian rate cut this year. Australia added 290,000 full-time jobs in the first nine months of 2024, a significant increase from the 143,000 added during the same period in 2023. The labour force participation rate hit a record 67.2%, up from 66.5% in September 2023, while the unemployment rate remained steady at 4.1%, consistent since the end of Q1. The futures market now assigns less than a 7% chance of a rate cut in November, and the odds for a December cut have fallen to 20%, the lowest since late July. The upcoming preliminary October PMI (October 24) is not expected to impact markets significantly, while the quarterly CPI data on October 30 is anticipated to be more influential for the Reserve Bank of Australia and investors.
Australian Dollar’s Sensitivity to China and Commodities
The Australian dollar remains highly sensitive to developments in China, its largest trading partner, as well as to shifts in commodity prices and trade terms. Last week, the currency found support just below $0.6660, approaching the 50% retracement of its rally from the August low ($0.6350) to the year’s high reached in late September ($0.6940). Although momentum indicators have not yet turned positive, the currency managed a four-day high close before the weekend. A break above $0.6720 could be constructive for the Australian dollar, but stronger resistance lies around $0.6760.
Key Points:
- September’s strong jobs report has significantly reduced the odds of an Australian rate cut this year.
- The labour market is showing strength with record participation and steady unemployment.
- The Australian dollar’s movements are influenced by China’s economic developments and global commodity trends.
- Key support for the currency is around $0.6660, with potential resistance at $0.6760.
Canada
Rate Cuts on the Agenda
The Bank of Canada is set to meet on October 23, having already cut rates three times this year. Governor Macklem has indicated there may be room to quicken the pace of rate cuts. Last week’s inflation report supports this notion, as headline inflation fell to 1.6% year-over-year through September, the lowest level since February 2021. Inflation has declined in three of the past four months, with a nearly 1% annualized rate of contraction. While core inflation measures are stickier, they still show a downward trend. The swaps market now sees an 85% chance of a 50 basis-point cut at the upcoming meeting, up from 55% a week ago, and is even considering the possibility of another cut in December.
Canadian Dollar Under Pressure Amid Yield Discrepancies
The recent slump in the Canadian dollar is linked less to inflation trends and more to the widening yield gap with the US. Canada’s two-year nominal yield is now nearly 100 basis points lower than the US Treasury’s, the largest difference since 1997. This discount has grown by about 35 basis points since the start of the month. The real policy rate, calculated by subtracting the current CPI from the overnight target, sits around 2.60%-2.65% for both Canada and the US, but this does not fully explain the Canadian dollar’s weakness.
Key Levels for the Canadian Dollar
The Canadian dollar has struggled this month, rising in only three of the past three weeks’ sessions, with two of those gains occurring last week. The US dollar reached a two-month high near CAD1.3840. Despite these setbacks, the Canadian dollar remains the best-performing G10 currency for October, down just 2%. A decisive break above or below the CAD1.3750-CAD1.3850 range could indicate the direction of the next significant move.
Key Points:
- The Bank of Canada may accelerate rate cuts, with an 85% chance of a 50 basis-point cut next week.
- Headline inflation dropped to its lowest level since early 2021, while core inflation shows a downward trend.
- The Canadian dollar faces pressure due to a growing yield gap with US rates, now the widest since 1997.
- Watch for a break in the CAD1.3750-CAD1.3850 range to determine the Canadian dollar’s next move.
China
Beijing’s Policy Strategy
Beijing may continue making gradual policy changes, but significant shifts are unlikely. The one-year Medium-Term Lending Facility downgraded as a policy tool, is expected to remain at 2% following a 30 basis-point cut last month and a 20 basis-point cut in July. The loan prime rates have not been adjusted since July, but a 20 basis-point cut is anticipated before Monday, potentially lowering the one-year rate to 3.15% and the five-year rate to 3.65%. The lack of specifics during last week’s fiscal briefing has turned attention to the upcoming Standing Committee meeting of the National People’s Congress (October 20-24). Critics are looking for fiscal measures to boost domestic demand, especially consumption.
BRICS Summit
The BRICS Summit (October 22-24) will likely echo the European Union’s experience of expanding membership while struggling to achieve deeper integration. As more countries join, the range of interests broadens, making timely decision-making harder. The group faces two internal contradictions: tensions between India and China and China’s push to internationalize the yuan through its China International Payment System (CIPS). Beijing’s willingness to support a competing platform or currency remains questionable. While BRICS members could agree to use their national currencies more frequently for trade settlement, progress in this area has been sluggish, raising questions about its feasibility.
US Dollar vs. Chinese Yuan
The US dollar has broadly strengthened since late September, rising from around CNH6.97 to nearly CNH7.15 last week. Breaking above this level could target the CNH7.18 range, with the 200-day moving average near CNH7.2035 as a potential upside marker. Previous resistance near CNH7.10 may now serve as support, followed by CNH7.08. Due to specific developments in Japan and China, the correlation between their currencies weakened recently but appears to be stabilizing.
Key Points:
- Beijing is likely to continue gradual policy adjustments, with a possible loan prime rate cut before Monday.
- The BRICS Summit faces challenges in balancing expansion with deeper cooperation, hindered by internal tensions.
- The US dollar’s recent rebound against the yuan targets CNH7.18 and CNH7.2035, with support levels around CNH7.10 and CNH7.08.
- The correlation between the Chinese yuan and Japanese yen is stabilizing after a period of weakness.
Europe
ECB Rate Cut Impact
The recent European Central Bank (ECB) rate cut may temper the market’s reaction to the upcoming preliminary October PMI data. A disappointing result could reinforce expectations for another rate cut at the December 12 ECB meeting. With September’s inflation below 2%, the central bank has more room to manoeuvre. Chief Economist Lane has already signalled a potential acceleration of the easing cycle if economic conditions continue to deteriorate.
Germany’s Economic Fragility
Germany’s economy is at a critical juncture and may be facing a second consecutive year of contraction, something not seen since 2002-2003. The upcoming IFO survey on October 25 is expected to reflect this vulnerability. Expectations have been declining for the last four months, and the current assessment index stood at 84.4 in September, its lowest level since mid-2020.
France’s Credit Review and Bond Market Dynamics
Moody’s will announce the results of its credit review for France on October 25. Currently rated Aa2, France faces a higher premium on its 10-year bonds compared to Germany, trading mostly within the 70-80 basis point range since late July. This premium was narrower in Q1 2024, at 45-55 basis points. Notably, France’s 10-year yield is now above that of Spain and Portugal.
Diverging Interest Rate Trends
The euro’s recent decline has been more significant than anticipated. After forming a double top around $1.12, it dropped to a low near $1.0810 last Thursday. It needs to recover above $1.0870, and ideally $1.09, for a more positive technical outlook. Contributing to the euro’s weakness is the widening US two-year yield premium over Germany, which surged from a low of 135 basis points in mid-September to nearly 190 basis points, the highest since late June. This yield spread highlights the differing economic trajectories and central bank policies in the US and Europe.
Key Points:
- The ECB rate cut has lessened market sensitivity to upcoming October PMI data, but poor results could prompt expectations of another rate cut in December.
- Germany’s economy risks a second consecutive year of contraction, with sentiment at its lowest since mid-2020.
- France’s credit rating review is scheduled for October 25, with bond market dynamics showing increased yields relative to Germany, Spain, and Portugal.
- The euro’s decline reflects the growing US-German yield spread, but a recovery above $1.0870-$1.09 could signal a turning point.
Japan
Bank of Japan Policy Outlook
The Bank of Japan (BOJ) is unlikely to alter its policy during the meeting scheduled for October 30-31, especially with the national election taking place on October 27. BOJ officials have not taken significant steps to prepare the market for any changes. After the dramatic policy adjustments in July, the BOJ is expected to approach the situation with caution and clarity. Key upcoming data includes the preliminary October PMI and the final estimate for September machine tool orders, which is anticipated to show a -6.5% year-over-year decline. However, the most critical indicator will be Tokyo’s October Consumer Price Index (CPI), as it serves as a reliable predictor for national figures released weeks later.
Tokyo’s CPI Signals National Figures
Recent national inflation data released last week confirmed the downward trend indicated by Tokyo’s figures. Tokyo’s core CPI, which excludes fresh food, peaked at 4.3% in January 2023 but has since halved, standing at 2.1% year-over-year in December 2023. In the first nine months of this year, it has averaged 2.1% and recorded a slight decrease to 2.0% in September. This sustained decline in inflation will likely influence the BOJ’s future policy decisions.
Correlation of Exchange Rates and US Yields
Interestingly, the exchange rate is more closely correlated with changes in US 10-year yields than with shifts in the 10-year yield differential, showing a correlation of 0.72 versus 0.54 on a 60-day rolling basis. This correlation is at its highest level since the spike in early 2020. The correlation between exchange rates and changes in the 10-year interest rate spread peaked slightly above 0.70 in February before dropping to a year-low of 0.32 in August, but it has since begun to recover. Currently, US 10-year yields appear to be stalling around 4.10%, which raises concerns that the US dollar may struggle to maintain its recent gains, including reaching approximately JPY150.30 in the latter half of last week.
Key Points:
- The BOJ is expected to maintain its current policy during the October 30-31 meeting, with little market preparation ahead of the national election.
- Tokyo’s CPI serves as a significant indicator for Japan’s inflation trends, with core inflation showing a consistent decline since early 2023.
- The exchange rate is more correlated with US 10-year yields than with the yield differential, reflecting changing market dynamics.
- US 10-year yields stalling around 4.10% may hinder the dollar’s ability to extend recent gains against the yen, with initial support seen near JPY148.85.
U.K.
Bank of England Rate Cut Expectations
The softer-than-expected September Consumer Price Index (CPI) has strengthened market expectations that the Bank of England (BoE) will implement its second quarter-point cut during its meeting on November 7. Before the CPI report, the overnight swaps market indicated over a 90% chance of a rate cut. The critical focus now shifts to the final meeting of the year on December 19. Following the CPI release, confidence in a December cut rose significantly, increasing from just under 50% to around 75%. This sentiment remained stable even after stronger-than-expected September retail sales figures. Upcoming data releases, such as CBI trends and preliminary PMI, are unlikely to significantly influence market expectations.
Labour Party’s Fiscal Challenges
With key economic reports behind it, the market’s attention turns to the Labour Party’s first budget following a challenging initial 100 days in power. Chancellor of the Exchequer, Reeves, has identified a £22 billion funding gap that needs addressing. However, the Labour Party has ruled out increasing key taxes, including VAT, employee contributions to the National Health Service (NHS), and income tax. This decision complicates efforts to close the funding gap, although other potential tax increases, such as raising the capital gains tax and adjusting business contributions to the NHS, are still on the table. These measures could undermine Prime Minister Starmer’s initiative to position Labour as the business-friendly party.
Sterling’s Recent Performance
Sterling traded below $1.30 for the first time in nearly two months last week, settling slightly above $1.2960, which corresponds to the 61.8% retracement level of the rally from the August 8 low near $1.2665. Following the stronger retail sales report, the currency rebounded to around $1.3070. A close above the $1.31 mark would reinforce the view that a low has been established. Meanwhile, the euro has reached a new 2.5-year low against sterling, dipping slightly below GBP0.8300 before recovering to around GBP0.8335 in North America. To improve its technical outlook, the euro needs to break through resistance in the GBP0.8350-80 range.
Key Points:
- The softer September CPI reinforces expectations for a Bank of England rate cut on November 7, with a 75% probability of a December cut following the CPI release.
- The Labour Party faces a £22 billion funding gap without raising major taxes, complicating fiscal policy efforts.
- Sterling dipped below $1.30 but recovered to about $1.3070, with a close above $1.31 suggesting a potential low.
- The euro reached a new 2.5-year low against sterling but must overcome the resistance around GBP0.8350-80 to strengthen its position.