28/09/2024 Market Analysis

Week Ahead: Jobs Data & Inflation

As we approach the week of September 30th, several key global events are expected to influence forex and bond markets. U.S. jobs data will be in the spotlight as it significantly shapes how quickly the Federal Reserve reduces interest rates, following its recent 50 basis point cut. Investors are paying close attention to how this data will affect the Fed’s monetary policy decisions moving forward. In Europe, inflation data from the eurozone is set to take centre stage, with rising speculation that the European Central Bank may implement another rate cut in October. This could considerably impact the euro’s performance in the coming weeks.

Looking at the G10 central banks, seven have already begun easing cycles, following the Federal Reserve’s recent actions. Australia is expected to follow this trend next year, while Canada could accelerate rate cuts by the fourth quarter of this year. However, Japan stands apart, as it has started to normalize its monetary policy by raising rates and reducing its balance sheet, signalling confidence in its economic outlook. Unlike other central banks, Japan’s decision to refrain from aggressive rate cuts highlights its focus on stabilizing prices and its economy.

The Japanese yen has experienced significant movement due to the unwinding of carry trades. Speculators in futures markets have shifted from short to long positions, which has supported the yen’s recovery. On the other hand, Japanese investors have increased their purchases of foreign bonds and stocks, showing a different approach from speculators. This divergence between speculators and investors demonstrates that Japan’s market intervention has been well-timed, coinciding with a peak in U.S. bond yields.

The euro, meanwhile, saw its value rise in late August, driven not by eurozone strength but by U.S. dollar weakness. The eurozone economy has shown limited growth, and much of the euro’s performance reflects changes in interest rate differentials between the U.S. and Germany. A narrowing U.S. rate premium has played a key role in supporting the euro’s recent gains.

Sterling has been the best-performing G10 currency this year, boosted by the Bank of England’s cautious stance and the UK’s rate premium over the U.S. With a potential rate cut in early November already priced in by the market, sterling’s outlook remains strong. However, further cuts may dampen its momentum. Other currencies, such as the Australian dollar, have seen moderate gains. The Canadian dollar has also struggled due to the Bank of Canada’s dovish policies.

Ultimately, the market remains sensitive to macroeconomic developments, and as central banks continue to adjust their policies, traders should stay alert to how these factors shape currency movements. Understanding rate differentials and monetary policy trends will be key in identifying opportunities in the weeks ahead.

United States of America

Fed Easing Cycle

The Federal Reserve initiated its easing cycle on September 18 with a 50 basis point (bp) rate cut. The recent Summary of Economic Projections indicated a further 50 bp reduction this year and 100 bp next year. Meanwhile, the derivatives market fully prices in an additional 75 bp of cuts for 2024. Chair Powell highlighted the Fed’s growing confidence in inflation returning to target levels, which allows the central bank to shift focus toward the slowing labour market. Acknowledging revised nonfarm payroll data, Powell emphasized the need to downplay short-term data fluctuations. If upcoming jobs reports show further weakness, expectations for a more aggressive easing cycle will strengthen, though the base case remains two quarter-point cuts.

Jobs Data in Focus

After the Fed’s significant rate cut in September, investors are closely watching upcoming labour market data, especially nonfarm payroll figures for September. The market expects 75 bp of rate cuts at the Fed’s November and December meetings, suggesting that one of those cuts could be another half-point. However, many analysts predict the Fed will lean toward quarter-point cuts. Should the labour market show signs of greater weakness, the Fed may be compelled to act more aggressively in reducing rates.

Economic Data to Watch

August’s jobs data showed no signs of a major downturn, but previous downward revisions signal that the labour market is cooling. Leading up to Friday’s nonfarm payroll release, investors will analyze other labour market indicators such as JOLTS job openings on Tuesday, ADP private payrolls on Wednesday, and weekly jobless claims on Thursday. This data will provide a clearer picture of the labour market’s health, influencing the Fed’s policy decisions.

U.S. Economic Performance

Other important data includes the ISM surveys for September, which cover manufacturing and services. The manufacturing sector is expected to remain weak, although some regional surveys hint at a recovery, particularly in new orders and shipments. Meanwhile, the services sector is expected to continue expanding. Investors will also look at durable goods orders for August, which are due on Thursday.

Treasury Auctions

The U.S. Treasury will auction Treasury bills, though there are no scheduled auctions for notes or bonds in the near term.

Key Points:

• The Federal Reserve is expected to make further rate cuts, with a base case of two 25 bp reductions.
• Jobs data, including nonfarm payrolls, will be critical in shaping rate expectations.
• Additional data, such as ISM activity surveys and durable goods orders, will provide insight into the U.S. economy’s health.
• Treasury bill auctions will take place, but no note or bond auctions are currently scheduled.

Australia

Australian Dollar Gains Momentum

In September, the Australian dollar rose by 2%, reaching its highest level since February 2023. This increase is largely due to the Reserve Bank of Australia’s (RBA) decision to maintain restrictive monetary policy, even as other G10 countries and the U.S. cut interest rates. Under Governor Bullock’s leadership, the RBA pushed back against market speculation of a rate cut. Earlier, there was an 80% chance of a cut by the end of the year, but now it’s less than 60%. Markets expect rates to decrease by 100 basis points next year. Key data, such as the October 17 employment report and the Q3 inflation report on October 30, will influence decisions at the RBA’s November 5 meeting.

China’s Influence on the Australian Dollar

Australia’s strong trade ties with China mean the Australian dollar often reacts to developments in China’s economy. The currency, along with the New Zealand dollar, received support from China’s recent stimulus efforts. However, technical indicators suggest that the Australian dollar may be nearing its peak, with the next target range being $0.7000-$0.7050.

Australian Bonds and Economic Indicators

This week, Australian bonds are expected to have a relatively quiet period, with no significant events tied to the RBA. However, August’s retail sales data, set to be released on Tuesday, will be important for understanding consumer demand, a key factor for future interest rate decisions. High interest rates have reduced consumer spending, slowed GDP growth, and increased pressure on the RBA to cut rates. A sharp drop in retail sales could raise concerns about an economic contraction in Q3.

Economic Outlook for Q4

Despite concerns about a slowdown, economists believe income-tax cuts will boost consumer spending in the last quarter of the year. This added momentum may help the economy recover in Q4. The RBA remains firm in its stance, indicating that interest rate cuts are not likely in the near term, as demand in the economy continues to exceed supply.

Key Points:

• The Australian dollar gained 2% in September due to restrictive monetary policy.
• Market expectations for a rate cut this year have decreased; major economic reports due in October.
• Australia’s currency is heavily influenced by China’s economic conditions.
• Retail sales and consumer demand will play a critical role in shaping the RBA’s future actions.
• Income-tax cuts may help boost the economy in Q4, but rate cuts are unlikely soon.

Canada

Bank of Canada’s Easing Momentum

The Bank of Canada has been one of the most aggressive G10 central banks in easing monetary policy, showing signs of accelerating its pace. Since June, the Bank of Canada has implemented three quarter-point rate cuts, and it seems likely that a larger 50-basis-point cut could occur at either the October 28 or December 11 meeting, with a bias toward the earlier date. This move is supported by a decline in August’s Consumer Price Index (CPI) and a weakening labour market, with the unemployment rate rising from 5.8% at the end of last year to 6.6% in August. The market is pricing in a continuation of this pace, expecting around 75 basis points of cuts per quarter through the first half of 2025.

Political Landscape and Economic Implications

Canada’s domestic political scene is also adding some uncertainty. Prime Minister Justin Trudeau’s minority Liberal government has lost support from the New Democratic Party, forcing him to negotiate on key issues one by one. Trudeau’s government has also lost several special elections, reflecting declining public support and raising questions about his political future. Although Trudeau survived a vote of no-confidence in late September, his position remains fragile. The Quebecois party has given him until the end of October to meet demands, such as improving pension benefits and protecting certain agricultural sectors from international trade agreements. If Trudeau’s government survives, national elections will be held in October 2025, but the opposition Conservatives, with a more business-friendly platform, are poised to lead the next government.

Canadian Dollar’s Sensitivity to Market Trends

The Canadian dollar’s exchange rate has shown a stronger correlation with the general movement of the U.S. dollar (Dollar Index) and global risk appetite (S&P 500) than with oil prices or short-term interest rate differentials. This suggests that broader market trends, rather than specific economic factors like oil, are driving the currency’s movement.

Key Points:

• Bank of Canada expected to cut rates by 50 basis points either in October or December.
• Weak labour market and declining inflation are driving expectations of further easing.
• Trudeau’s minority government is under political pressure, with an uncertain future.
• The Canadian dollar is more influenced by U.S. dollar movements and risk sentiment than oil prices.

Europe

Eurozone Economic Context

The euro has appreciated for the third consecutive month in September, but this rise does not signify a robust economy. Rather, it reflects a backdrop of economic malaise within the Eurozone. The manufacturing sector continues to struggle under the weight of uncompetitively high energy prices, which hampers competitiveness. The euro’s rise can be largely attributed to a broader decline in the U.S. dollar. As the premium of U.S. interest rates over Germany decreased—from nearly 200 basis points at the end of June to around 130 basis points after the Federal Reserve’s recent rate cut—the dollar depreciated accordingly.

ECB Meeting and Market Expectations

The European Central Bank (ECB) is scheduled to meet on October 17, where the likelihood of a back-to-back rate cut has increased. While there were initial hesitations about reducing rates consecutively, the Fed’s recent move may have provided the ECB with room to manoeuvre. Furthermore, the economic news stream has been discouraging, and inflation appears to have cooled further in September. The swaps market is pricing in an 80% chance of an October cut, anticipating that the ECB may lower the deposit rate from its current peak of 4% to around 2% by mid-next year.

Upcoming Inflation Data

Provisional eurozone inflation data for September, due to be released on Tuesday, will be closely scrutinized as analysts and investors speculate on the likelihood of the ECB opting for interest-rate cuts. This follows recent provisional inflation figures from France and Spain, which were significantly lower than expected. According to Capital Economics, these figures suggest a sharp decline in the headline rate for the eurozone, likely falling below the 2% target, further solidifying the case for a rate cut in October.

Key Economic Indicators

In the lead-up to the inflation data, provisional figures for Germany and Italy will be released on Monday, offering insights into the overall eurozone economic landscape. Additionally, eurozone producer prices for August will be published on Thursday, providing indications of pipeline inflationary pressures. Final purchasing managers’ surveys for France, Germany, and the eurozone are also scheduled for release, with a focus on manufacturing and services.

European industrial data remains weak, though there are expectations for a rebound in France’s industrial production, projected to rise by 0.5% month-on-month in August after a decline in July. Analysts note positive signals from the Bank of France survey, which highlights an uptick in activity across sectors like food, chemicals, pharmaceuticals, and wood/paper.

Bond Auctions and Market Activity

In the bond market, Germany will auction €4 billion in October 2029 federal notes and €4.5 billion in August 2034 Bunds this week. Spain will tap three conventional bonds and an inflation-linked bond, while France plans to auction €10 billion to €12 billion in long-dated bonds, including a green bond.

Key Points:

• The euro’s rise is driven by a decline in the U.S. dollar rather than economic strength.
• ECB meeting on October 17 may see back-to-back rate cuts, influenced by recent Fed actions.
• Provisional inflation data for September is expected to show a decline below the 2% target, strengthening the case for rate cuts.
• Industrial production in France may rebound, indicating some sectoral resilience.
• Upcoming bond auctions highlight ongoing market activity despite economic uncertainties.

Japan

Japan’s Political Landscape

Japan joins the ranks of G5 nations experiencing government transitions this year, following Labour’s win in the UK and the emergence of a new prime minister in France, although Macron remains in the presidential seat. The extent of policy changes under Prime Minister Ishiba remains uncertain. His strong defence stance may have been more influential in securing his position than his plans to revitalize the struggling regions affected by a declining population. Ishiba’s rise comes against a backdrop of geopolitical tensions, notably a tragic incident in China and Beijing’s aggressive posturing, which seem to have played a role in shaping public sentiment in his favour.

Economic Recovery and Central Bank Policy

Two key aspects characterize Japan’s current economic and business environment. First, after experiencing contraction in the first two quarters of the year, the Japanese economy is beginning to show signs of modest growth, with expectations for improvement continuing into the first half of next year. Second, the Bank of Japan (BOJ) is adopting a tightening bias, indicating its intention to raise interest rates unless unforeseen economic shocks occur. The market currently anticipates no interest rate hike at the upcoming BOJ meetings on October 31 and December 19, pushing the expected timeline for the next rate increase into 2025.

Upcoming Economic Data

The week in Japan kicks off with retail sales and industrial production data for August, setting the stage for further insights into the economy’s health. Tuesday brings crucial job market data alongside the BOJ’s Tankan survey, which measures business sentiment. Economists predict the sentiment index for large manufacturers will hold steady at +13, reflecting a cautious outlook influenced by several factors. While the disruptions caused by some automakers’ production halts have subsided, challenges such as yen appreciation, China’s economic slowdown, and natural disasters may dampen overall optimism.

Industrial Production Insights

Industrial production figures are likely to show a decline in August, partly attributed to disruptions from typhoons. Economists indicate that near-term manufacturing sentiment, as reflected in the manufacturing PMI, appears to be stagnating due to an uncertain external environment and exchange rate volatility impacting the outlook.

Key Events and Auctions

On Thursday, all eyes will be on BOJ policy board member Asahi Noguchi, who is set to deliver a speech in Nagasaki. Known for his dovish stance, Noguchi previously opposed the decision to raise interest rates to 0.25% in July. Additionally, the Ministry of Finance plans to auction ¥2.6 trillion ($17.95 billion) in two-year sovereign notes on Monday and another ¥2.6 trillion in 10-year government bonds on Thursday. Potential political developments, including the formation of Ishiba’s cabinet, may also draw attention as the new government settles into its role.

Key Points:

• Japan’s political landscape shifted with Prime Minister Ishiba’s leadership, focusing on defence rather than regional revitalization.
• The economy is expected to show modest growth after earlier contractions, with the BOJ signalling intentions for interest rate hikes.
• Key economic data this week includes retail sales, industrial production, and the BOJ’s Tankan survey.
• Industrial production likely declined in August due to typhoon disruptions and external economic pressures.
• Upcoming bond auctions and BOJ speeches will be pivotal for market sentiment and economic direction.

Switzerland

Swiss inflation data for September is set to be released on Thursday, capturing significant attention from analysts and investors alike. This follows the Swiss National Bank’s recent decision to cut interest rates and revise its inflation forecasts downward.

United Kingdom

Sterling’s Performance in September

The Bank of England’s patient approach, now reflected in the highest policy rate among G10 nations (alongside New Zealand), has helped the British pound outperform in September. At its peak, sterling appreciated by approximately 1.7%, reaching around $1.34, a level it hasn’t seen since March 2022. The trajectory of future rate cuts is heavily dependent on inflation, particularly the persistence of service prices. The Consumer Price Index (CPI) for September is scheduled for release on October 16, which will provide crucial insights.

Rate Cut Expectations

Despite the uncertain landscape, the market appears confident about a potential rate cut in November. However, whether the Bank of England will also implement a cut in December remains an open question, with the swaps market indicating about a 60% probability of such a move. The stagnation of the monthly GDP measure in June and July adds weight to this discussion, and another month of stagnation (with the August GDP report due on October 11) could reinforce calls for lower rates.

Fiscal Policy Considerations

The fiscal landscape will also play a vital role, particularly with Chancellor Reeves’ Autumn Budget set for the end of the month. There is considerable speculation regarding how the government plans to address the budget gap it claims to have inherited, with a focus on potential reforms in capital gains and inheritance tax.

Potential for Sterling

Looking ahead, sterling could have further potential in the coming weeks, with targets between $1.3500 and $1.3650. Meanwhile, support is holding at $1.30. However, it is worth noting that sterling has rallied over four cents since the US CPI report on September 11, leading to stretched short-term momentum indicators that warn of a possible correction.

Key Points:

• The Bank of England’s high policy rate has contributed to a strong performance for the British pound in September.
• Market confidence suggests a potential rate cut in November, with a 60% chance for December cuts as well.
• Upcoming economic data, including the September CPI and August GDP, will influence future monetary policy decisions.
• The UK government’s Autumn Budget will be key in addressing the budget gap and may impact market expectations.
• Sterling may reach $1.3500-$1.3650 in the coming weeks, though risks of a correction are present.