12/10/2024 Market Analysis

Week Ahead: USD Stalls, Market Shifts Focus to Europe’s Rate Decisions

The US dollar and interest rates surged following stronger-than-expected September jobs data and firm inflation readings, although Federal Reserve officials’ views seemed largely unaffected. The latest Summary of Economic Projections showed a split on rate cut expectations for Q4, with ten officials supporting a 50 basis point reduction, while seven favoured a smaller, quarter-point cut. Ahead of the jobs report, markets had priced in nearly 67 basis points of rate cuts for the rest of the year, which later settled to around 45 basis points. It appears that the recent rate hike momentum is close to peaking. Key support levels in the forex market, such as $1.09 for the euro, $1.30 for the pound, and $0.6700 for the Australian dollar, have held firm during the initial tests, and technical indicators suggest the dollar’s rally may be losing steam.

Attention is now shifting to Europe, focusing on the upcoming European Central Bank (ECB) meeting, where another rate cut is expected following September’s move, especially after the latest CPI dropped below 2%. The Bank of England’s policy outlook will hinge on upcoming employment and inflation data in the UK. Slower wage growth, softer inflation—including services—and declining retail sales could strengthen expectations for rate cuts in November and December.

In the US, the focus will return to fine-tuning Q3 GDP estimates, with retail sales and industrial production data due on October 17. Current GDP growth forecasts from the Atlanta and New York Fed are close, around 3.1%-3.2%, while a survey of economists suggests a more modest 2.1% growth rate.

United States of America

Fine-Tuning Q3 Growth Expectations

This week’s economic updates focus on adjusting expectations for third-quarter growth, which remains above the Federal Reserve’s long-term non-inflationary pace. Although consumer credit growth has slowed, and household debt stress is elevated, American consumers continue to spend. A rise in auto sales likely boosted September retail sales, while industrial production probably eased after a strong 0.8% gain in August. Likewise, housing starts, which surged 9.6% in August, are expected to have moderated. While these reports could influence market sentiment, they are not likely to change the current outlook for a 25 basis point rate cut in November.

Restrictive Monetary Policy and Future Implications

Monetary policy remains restrictive, even though its exact impact is difficult to measure and open to debate. With variable time lags in policy effects, the current settings are focused more on likely economic conditions in the future rather than the present. The Fed’s approach is geared toward managing potential risks in the upcoming months rather than reacting solely to recent data.

Dollar Index Momentum Shows Signs of Easing

The Dollar Index (DXY) has risen 3% since testing the 100 level in late September, supported by strong US jobs data and firm inflation readings. This rally has allowed the DXY to recover about half of its losses since peaking above 106 in late June. If it breaks above 103.15, the index could target the 103.75-104.00 range. However, momentum indicators are showing signs of weakening, suggesting caution is warranted. The initial support level is near 102.50.

Key Points:

• Q3 growth still exceeds the Fed’s long-term non-inflationary pace.
• Retail sales got a boost from auto sales, while industrial output and housing starts may have softened.
• A 25 basis point rate cut in November remains the market’s expectation.
• The Dollar Index has rallied 3% but is showing signs of losing steam, with key support at 102.50.

Australia

Market Expectations and RBA’s Rate Cut Signals

Despite the Reserve Bank of Australia (RBA) signalling that a rate cut this year is unlikely, the market continues to resist, with futures still pricing in a 50% chance of a cut, down from nearly 75% on October 1. The RBA attributes the strength in demand to a resilient labour market. Australia’s September jobs report, set for release on October 17, will be crucial, as job creation remains strong with 311,000 new positions added by August. This year has seen faster full-time job growth (~242,000) compared to last year (~182,000). However, the unemployment rate has inched higher to 4.2% in July and August, as the participation rate rose from 66.6% in January to 67.1% in August. Another key indicator ahead of the RBA’s November 5 meeting is the quarterly CPI report on October 30, where a slight decrease is expected following Q2’s increase to 3.8% from 3.6%.

Australian Dollar Holds Key Support Levels

The Australian dollar found support at $0.6700 on October 10 and rebounded to just above $0.6760 ahead of China’s briefing on October 12. Momentum indicators are currently stretched, suggesting caution. A break below $0.6700 could lead to a decline toward the $0.6625-$0.6650 range. Conversely, if support holds, a move above $0.6775 would be a positive development, with stronger resistance in the $0.6800-$0.6815 area.

Key Points:

• The market still sees a 50% chance of a rate cut this year despite RBA signals.
• Strong job growth (311,000 new jobs) is supporting demand, though unemployment has edged up.
• Key data ahead of the November 5 RBA meeting include the October 17 jobs report and October 30 CPI.
• The Australian dollar is testing support at $0.6700, with potential targets both above and below current levels.

Canada

Canadian Dollar Faces Continued Weakness Despite Strong Jobs Data

Canada’s labour market showed impressive strength, with the unemployment rate dropping and full-time jobs surging by 112,000 in September—the largest increase since May 2022. However, this was not enough to prevent the Canadian dollar from extending its losses for an eighth consecutive session. The upcoming CPI report will be a crucial data point ahead of the Bank of Canada’s October 23 meeting, where a fourth rate cut is widely anticipated. The question remains whether the central bank will opt for a larger 50 basis point (bp) cut. While expectations for a 50 bp cut peaked at 80% on September 27, they have slightly moderated but remain tilted toward a more aggressive move. The swaps market is pricing in nearly 72 bp of cuts across the two remaining meetings this year.

Inflation Trends Provide Mixed Signals

Canada’s inflation has sharply decelerated in recent months, falling from 2.9% year-over-year in January to 2.0% by August. For the last four months of 2023, CPI was essentially flat, and in the three months through August, it rose at an annualized pace of under 0.5%. The September CPI, expected to show a 0.2% monthly decline, could bring the year-over-year rate below 2.0%. However, the Bank of Canada places greater emphasis on core inflation, which has eased to 2.3%-2.4% over the past three months but is likely to have steadied in September.

Canadian Dollar Faces Technical Pressures Amid Broad Market Trends

The Canadian dollar was the weakest G10 currency last week, falling 1.35% against the US dollar. The New Zealand dollar also struggled, becoming the second worst G10 performer after the Reserve Bank of New Zealand delivered a 50 bp rate cut. For the Canadian dollar, a test of CAD1.3800 against the greenback seems probable, though the recent move appears exaggerated.

Key Points:

• Canadian unemployment rate fell, and job growth surged in September.
• The Bank of Canada is likely to cut rates on October 23, with a potential 50 bp move in focus.
• Inflation has slowed, but core measures remain around 2.3%-2.4%.
• The Canadian dollar’s slide continues, with technical indicators suggesting a possible reversal.

Europe

ECB Rate Cut Expectations Rise Amid Weak Inflation Data

The European Central Bank (ECB) had been comfortably delivering a 25 basis point (bp) rate cut each quarter, but recent developments have shifted market expectations. September’s inflation reports showed a quicker-than-expected decline in price pressures, with the four largest Eurozone economies reporting inflation below 2%. The preliminary aggregate reading for the region was 1.8%, prompting speculation that the ECB could deliver another rate cut this week, following last month’s quarter-point reduction. With more than a 90% chance of a cut priced in, according to the swaps market, maintaining the current rates would likely cause more disruption than executing a back-to-back cut. Another rate cut is nearly fully priced in for December as well.

Euro Faces Pressure Near Key Support Levels

The euro tested support at $1.09 on October 10, but the bounce that followed was limited, recovering slightly more than half a cent. If the $1.09 level breaks, the next target could be in the $1.0875-$1.0880 range, while a double-top formation around $1.12 suggests a potential objective of $1.08. The euro has already retraced three cents, and momentum indicators are beginning to show signs of being stretched. Confidence in resistance at $1.12 was initially supported by the widening of the US two-year yield premium over Germany, which favoured the dollar. However, the opposite trend has recently emerged, with the US premium narrowing in three of the past four sessions. A move above the $1.10 level is needed to indicate a significant shift from a technical standpoint.

Key Points:

• The market anticipates a second consecutive 25 bp rate cut from the ECB due to weaker inflation data.
• September’s inflation fell below 2% across the Eurozone’s four largest economies, with the region’s preliminary reading at 1.8%.
• The euro’s recent bounce from $1.09 was limited, and a break could target the $1.0875-$1.0880 area.
• The narrowing US-German yield spread may reduce support for the dollar, but the $1.10 level remains a key technical barrier.

Japan

Japan’s Fiscal Package and Monetary Policy Outlook

Japan’s new government is assembling a fiscal package aimed at mitigating the effects of high prices on households while signalling caution over further rate hikes. The upcoming September Consumer Price Index (CPI) report is not expected to significantly shift expectations, as key insights have already been derived from the Tokyo CPI, which showed moderation in headline and core inflation while the measure excluding energy and fresh food remained unchanged. Additionally, with a snap election just before the October 30-31 Bank of Japan (BOJ) meeting, the central bank is unlikely to make sudden moves. Governor Ueda’s cautious tone suggests the BOJ will maintain current policy settings, especially after the market’s strong reaction to the July decision to hike rates and begin quantitative tightening (QT). Although the swaps market indicates about eight basis points of tightening priced in for December, many economists now expect the next hike to be postponed until 2025.

Yen Weakens as US Yields Rise

The yen fell against the dollar, driven by higher US interest rates. The 10-year Treasury yield rose by 12 basis points last week, marking its fourth consecutive weekly gain and reaching 4.12%, the highest since late July. This supported the dollar’s rise to JPY149.55, its strongest level since August 1. The potential for further gains extends into the JPY150-JPY151 range, although stretched momentum indicators suggest that additional increases in US yields may be needed. With the 10-year yield settling near 4.10%, further advances toward 4.15%-4.20% appear possible.

Key Points:

• Japan’s new fiscal package aims to support households amid high prices, with little expectation for further rate hikes.
• September CPI is unlikely to change outlooks, as Tokyo CPI already signalled moderation.
• The BOJ is expected to maintain current policy settings at the October meeting, with the next rate hike potentially delayed until 2025.
• The yen weakened as US Treasury yields climbed, pushing the dollar to JPY149.55, with the potential for further gains if US yields continue rising.

United Kingdom

Labour and Inflation in Focus

The week brings significant data for the UK, with two key reports expected to influence market sentiment. On October 15, the labour market update will provide insights into the state of employment. UK payrolls dropped by 24.5k through August, contrasting with a gain of 271k during the first eight months of the year. However, policymakers appear more concerned with average weekly earnings, which rose 5.1% year-over-year in the three months through August (excluding bonuses). Higher wages contribute to persistent services inflation, although earnings are anticipated to show signs of slowing, alongside modest job growth. The economy grew by 0.2% in August, offering some optimism.

The Consumer Price Index (CPI) for September will be released on October 16, following a 5.6% annual increase in services inflation through August (down from 6.8% in August 2023). A projected 0.1% rise in the headline CPI would lower the annual rate from 2.2% in August to 1.9%. However, this might represent a temporary low, with the base effect likely influencing the next few months due to last year’s flat CPI in October and -0.2% in November. At week’s end, retail sales data for September are expected, with forecasts suggesting a slowdown following August’s 1.1% growth (excluding fuel). The market is highly confident (90%+) of a Bank of England rate cut in November, with a 55% chance of an additional December cut.

Sterling’s Recent Downtrend

The British pound fell nearly 4.2 cents from its late-September high of ~$1.3435 to its October 10 low of ~$1.3020. While bids emerged above $1.3000, the rebound lacks strong momentum. For a more convincing recovery, the pound needs to climb back above $1.3120. Despite oversold conditions, another downward move remains possible, and a break below $1.3000 could trigger further losses, potentially extending by another half-cent.

Key Points:

• UK labour market data will focus on wage growth and employment trends; earnings are expected to slow in August despite prior resilience.
• September CPI report may show a drop to 1.9% year-over-year, but higher readings could follow due to base effects.
• Retail sales likely slowed in September after a robust August.
• The market is highly confident of a November Bank of England rate cut, with a possible follow-up in December.
• Sterling’s rebound lacks conviction, and a break below $1.3000 could trigger further declines.