16/11/2024 Market Analysis

Week Ahead: Markets on Edge, FX & Bond Drivers

U.S. economic data will remain a primary focus as the Federal Reserve approaches interest rate decisions cautiously. October’s inflation uptick and potential inflationary pressures from the President-elect’s policies have added complexity to the outlook. Additionally, Purchasing Managers’ Index (PMI) data from the U.S. will serve as a crucial gauge for market sentiment.

Across the globe, PMI surveys in the Eurozone, U.K., and U.S. will provide fresh insights into economic activity. The U.K.’s October inflation data, in particular, holds significant weight. Markets are closely watching whether the data could revive hopes for a Bank of England rate cut at its December meeting, though only a notably weak reading is likely to sway expectations.

The U.S. Dollar Index has been on a seven-week winning streak in the capital markets, underpinned by robust yield dynamics. The 2-year Treasury yield has surged from 3.55% in late September to 4.38%, while the 10-year yield reached 4.50%, marking a substantial rise since mid-September. However, much of this increase stems from factors beyond inflation expectations, including anticipated Fed rate adjustments, supply premiums linked to fiscal deficits, and the risk of a U.S. credit rating downgrade. While Moody’s maintains a AAA rating with a negative outlook, S&P and Fitch have already rated the U.S. at AA+.

Central bank activity will be relatively quiet until December, though China could consider rate cuts soon. That said, significant easing is unlikely in the immediate term. Meanwhile, the October inflation print in Canada will influence whether the Bank of Canada opts for a 50 basis point rate cut next month or a more modest 25 basis points.

Later in the week, preliminary November PMI data will be closely monitored, particularly in Europe, as it tends to have a notable impact on markets. Investors will also watch U.S. administration developments, with several senior appointments yet to be announced, including the Treasury and Commerce secretaries and the U.S. Trade Representative.

The combination of inflation pressures, fiscal dynamics, and central bank positioning will drive FX and bond markets this week, with global data releases and U.S. policy developments at the forefront.

United States of America

Inflation and Fed Policy in Focus

October’s inflation rise and expectations of potentially inflationary policies under the new administration are key areas of attention. While a December rate cut remains a possibility, the outlook has become more uncertain. Analysts suggest that inflation concerns, including the potential impact of higher tariffs, are unlikely to shift the Fed’s current path in the near term.

Fed’s Cutting Pace May Slow

The Federal Reserve may reduce its rate-cutting frequency to every other meeting by early 2025, according to market strategists. Current futures pricing reflects a 62% likelihood of a quarter-point cut at December’s Federal Open Market Committee (FOMC) meeting, along with nearly 75 basis points of cuts anticipated through next year.

Key U.S. Data Releases

This week’s economic calendar includes weekly jobless claims and existing home sales on Thursday. On Friday, markets will watch for the flash PMI estimates and the University of Michigan’s consumer sentiment survey. These data points, while important, are unlikely to decisively influence monetary policy.

Treasury Auctions in Focus

The U.S. Treasury is set to auction $16 billion in 20-year bonds on Wednesday and $17 billion in 10-year notes on Thursday. These auctions are likely to draw investor interest amid ongoing discussions of fiscal policy under the new administration.

Dollar Index Technical Outlook

The Dollar Index hit 107.00 last week, marking its highest level since October 2023. A breach above the 2023 high of 107.40 could open the door to a 109.00 target. However, initial support is seen at 106.20-40, with a close below the five-day moving average (~106.25) signalling potential weakness in the rally.

Key Points:

• Inflation pressures and Federal Reserve policy remain the primary market drivers.
• Weekly jobless claims and Friday’s PMIs will offer insights into U.S. economic conditions.
• Treasury auctions and Dollar Index performance will be closely monitored for additional market signals.

Australia

Central Bank Minutes and Market Expectations

The minutes from this month’s central bank meeting, due early Tuesday, are unlikely to be market movers. While the likelihood of further rate hikes has faded, officials have emphasized that policy will remain steady for the foreseeable future. Futures markets currently reflect a 60% probability of a rate cut in April 2025, with the first cut fully priced for May.

Australian PMI Data and Dollar Performance

Another key event this week is the preliminary November PMI. The Australian composite PMI has alternated between growth and contraction over the past four months, hovering near the critical 50 level. It stood at 50.2 in October, reflecting stagnation. Meanwhile, the Australian dollar has declined for six consecutive sessions, losing 3.6%. Last week, it fell to $0.6440, nearing the year’s low of $0.6350 recorded in early August.

Reserve Bank of Australia Communications

This week will feature significant communication from the Reserve Bank of Australia (RBA), including a speech by Governor Michele Bullock on Thursday. While the RBA has yet to indicate that interest-rate cuts are imminent, the central bank has maintained that all options, including potential hikes, remain on the table.

Shifting Market Expectations

The publication of the RBA’s meeting minutes on Tuesday will be closely monitored, as they occur amid significant shifts in the overnight index swap (OIS) market and bond yields. The OIS market has now delayed pricing in a rate cut until August, a stark change from six weeks ago, when a February cut seemed likely. Sticky domestic inflation and global asset market surges following the election victory of the President-elect have further complicated the outlook.

Key Points:

• Central bank minutes are expected to reaffirm a steady policy stance, with the first-rate cut not fully priced until mid-2025.
• Preliminary PMI data and the Australian dollar’s performance highlight economic stagnation and currency pressure.
• The RBA’s communications this week will provide important signals, though no immediate rate cuts are expected.
• Market expectations have shifted significantly, with inflation and global market trends adding to uncertainty.

Canada

Canada’s October Inflation in Focus

Canada’s October Consumer Price Index (CPI) will be the primary focus this week, with data set to be released on Tuesday. Inflation in September fell to an annual rate of 1.6%, its lowest since February 2021 and below the Bank of Canada’s 2% target. This decline has led the Bank of Canada to cut rates aggressively, including a 50-basis-point cut in October, bringing the target rate to 3.75%. Another rate cut at the December 12 meeting is possible, with the swaps market pricing a slightly better than 50% chance of another half-point reduction.

Housing Starts and Retail Sales

On Monday, Canada will release October housing starts data, while the week concludes with September retail sales figures. Retail sales have shown resilience, increasing 0.9% in July and 0.4% in August. Preliminary estimates suggest another 0.4% rise in October, indicating steady consumer activity despite broader economic challenges.

Canadian Dollar Under Pressure

The Canadian dollar was one of the top G10 performers last week but still fell by more than 1%, reaching its lowest level since the pandemic. The currency begins the week on a six-session losing streak, with further weakness potentially targeting CAD1.42 against the U.S. dollar. The Covid-era high of CAD1.4670 remains distant, but the U.S. dollar’s strength has driven volatility higher, with three-month implied volatility nearing 5.6%, its highest since April.

Yield Spreads Widening

The U.S. two-year yield premium over Canada has risen for seven consecutive weeks, expanding from 65 basis points at the end of Q3 to nearly 118 basis points, the widest since 1997. This yield differential continues to weigh on the Canadian dollar, reflecting diverging economic outlooks and central bank policies.

Key Points:

• October inflation data will shape expectations for the Bank of Canada’s December 12 rate decision.
• Housing starts and retail sales will provide additional insights into Canada’s economic health.
• The Canadian dollar faces ongoing pressure from a strong U.S. dollar and widening yield spreads.
• Market volatility is increasing, adding to the uncertainty around currency movements.

China

Limited Policy Action Disappoints Investors

The National People’s Congress failed to deliver bold new initiatives, leaving investors underwhelmed. Its primary accomplishment was adding details to a previously announced debt swap program for local governments, totalling CNY10 trillion (~$1.4 trillion), set to run through 2028. October’s real sector data, released ahead of the weekend, also failed to inspire confidence. The CSI 300 fell by 1.75% on Friday, contributing to a notable weekly loss, and highlighting market frustration. Beijing’s reluctance to announce fresh fiscal measures may be a strategy to preserve flexibility in responding to potential U.S. policy shifts under the new administration.

Yuan Weakness Amid Dollar Strength

The dollar strengthened by approximately 2.5% against the offshore yuan since the U.S. election, peaking at CNH7.2665 on November 14 before easing slightly to CNH7.23. The People’s Bank of China (PBOC) adjusted its reference rate higher than expected last week, a move that paradoxically limits further yuan depreciation due to the exchange rate’s 2% deviation cap. This policy adjustment reflects Beijing’s cautious management of currency movements amid broader market volatility.

Quiet Week Ahead in China

Following a wave of economic data, China enters a relatively subdued week. Loan prime rates, the country’s benchmark lending rates guiding mortgages, are expected to remain unchanged on Wednesday. Despite last month’s steep borrowing cost cuts, economists anticipate minimal additional monetary easing in the near term.

Eyes on December’s Policy Conference

Attention now shifts to the December Central Economic Work Conference, where China’s top leadership will outline policy priorities for 2025. While major fiscal initiatives are unlikely given Beijing’s conservative stance, incremental policy adjustments or surprise announcements cannot be ruled out.

Key Points:

• The lack of bold fiscal measures from the National People’s Congress disappointed markets, with key equity indices reflecting this sentiment.
• The yuan remains under pressure, with traders closely monitoring PBOC’s actions and potential further depreciation.
• Loan prime rates are expected to stay steady this week, with limited scope for additional monetary easing.
• December’s policy conference will be crucial for insights into Beijing’s economic priorities and potential surprises.

Europe

Eurozone PMI Under the Spotlight

The preliminary November PMI for the eurozone takes centre stage this week. After dipping below 50 in September, the composite PMI returned to the neutral 50 mark in October. However, economic activity remains fragile, hovering near stagnation levels. Services are slightly in expansion, while manufacturing remains subdued. Germany, the bloc’s largest economy, faces additional uncertainty following the collapse of its governing coalition, further complicating its fiscal path.

ECB Rate Cut Expectations

The market is increasingly confident that the European Central Bank (ECB) will cut rates in December, possibly by 50 basis points. This sentiment contrasts with the Federal Reserve and the Bank of England, where rate cuts appear less certain. Interest rate differentials remain relatively stable despite the eurozone’s political challenges. However, the widening premium of U.S. two-year yields over German bonds, now at 225 basis points, adds pressure on the euro.

Euro Outlook: Bearish with Resistance Ahead

The euro has sold off sharply, losing 4.4 cents since the U.S. election. Despite Friday marking the first day in six sessions without a lower low, upward momentum remains weak. The $1.06 area serves as a significant cap, with resistance around $1.0620. A retest of the 2023 low near $1.0450 seems likely in the days ahead.

Events to Watch

• Tuesday: Eurozone balance of payments (September) and final CPI data (October).
• Wednesday: Germany’s PPI (October) and ECB’s Financial Stability Review.
• Thursday: France’s business survey and eurozone consumer confidence flash estimate.
• Friday: Breakdown of Germany’s Q3 GDP and flash PMIs for France, Germany, and the eurozone.

Government Bond Auctions

A busy week for bond auctions includes Slovakia and Belgium on Monday, Finland on Tuesday, Greece and Germany on Wednesday, and Spain and France on Thursday. Germany will auction long-dated Bunds from 2052 and 2053.

Key Points:

• Eurozone PMI and ECB rate expectations dominate market attention.
• Euro remains under pressure, with bearish momentum persisting.
• Political uncertainty and data releases across the week could influence sentiment further.

Japan

Japan’s Political Landscape and Economic Outlook

Japan’s first minority government is now in place, with Prime Minister Ishiba leading the Liberal Democratic Party (LDP). The LDP, along with its traditional coalition partner, the Komeito Party, lacks a majority in the lower chamber of the Diet, but no viable opposition alternative has emerged. The immediate focus will be on a supplemental budget, which is expected to pass smoothly, though debates over potential tax increases, particularly for defence spending, may stir controversy.

BOJ Rate Hike Expectations

The swaps market has priced in a modest tightening bias for the Bank of Japan (BOJ) at its upcoming meeting, with expectations ranging between 5 and 12 basis points in the next few weeks. The yen’s recent weakness may have influenced this market sentiment. By mid-2024, the swaps market is pricing in roughly 32 basis points of tightening, a notable increase from a month ago.

Japan’s Trade Deficit and Economic Indicators

Despite the yen’s weakness, Japan continues to run a trade deficit, which stood at JPY4.9 trillion (~$32.5 billion) through September. However, Japan’s current account remains in surplus, largely due to past foreign investments in bonds, stocks, and other assets. This week, Japan will report its October trade balance, which may highlight these ongoing imbalances.

CPI and PMI Data

• CPI: Japan’s national CPI for October is expected to soften to around 2.2%-2.3% from 2.5% in September, with core inflation likely moderating slightly. The Tokyo CPI report for October, released earlier, already indicated a softer headline inflation rate, primarily due to energy subsidies.
• PMI: Japan’s preliminary PMI data will also be released, but markets typically do not react strongly to this data, as it does not provide significant surprises compared to other economic indicators.

USD/JPY and Market Movements

The dollar reached a high of JPY156.75 before reversing to nearly JPY153.85, completing a key reversal and snapping a four-day uptrend. The USD/JPY remains in a strong uptrend, having settled higher for six of the last seven weeks. Immediate support is seen near JPY153.35, with the 20-day moving average at JPY153.10, which has not been breached since late September.

Events to Watch

• Monday: BOJ Governor Ueda will speak to business leaders in Nagoya, addressing concerns around the yen’s depreciation and potential interest-rate hikes.
• Thursday: Ueda will participate in a forum with Bank of France Governor Villeroy de Galhau in Tokyo.
• Friday: October nationwide CPI data, machinery orders (September), and trade balance (October) are all scheduled for release.

Bond Auctions

• Thursday: The Ministry of Finance will auction JPY1 trillion of 20-year government bonds. Given the high yield and long tenure, institutional investors like insurance companies and pension funds are expected to show interest.

Key Points:

• Political Focus: Japan’s first minority government will prioritize a supplemental budget, with potential debates over defence spending.
• BOJ’s Dilemma: Tightening expectations rise, with some economists forecasting a rate hike in December or January.
• Trade and Inflation: Japan continues to run a trade deficit, but a current account surplus helps cushion the economic impact. Inflation data is expected to soften, with the impact of energy subsidies continuing to play a key role.
• Market Outlook: USD/JPY remains bullish with some short-term pullbacks, while bond auctions and CPI data will provide further insights into Japan’s economic health.

United Kingdom

U.K. Economic Data and Market Outlook

• Gilt Auction (Tuesday): The U.K. will auction the January 2038 gilt on Tuesday, which is of particular interest to investors in government bonds. The auction could provide insights into investor sentiment regarding long-term U.K. debt.
• Inflation Data (Wednesday): U.K. inflation data for October is expected to show a rise in headline inflation, likely surpassing the 2% target. The key driver is anticipated to be the increase in the energy price cap. Analysts from Investec have highlighted this factor as the primary influence on the inflationary rise. The previous reading for September was 1.7%. The upcoming report is crucial as it will shape the Bank of England’s (BOE) decisions in the near term.
• Public Sector Finance Data (Thursday): The U.K. will release its public sector finance data for October, which will provide insights into government borrowing and fiscal health. This data will be important for understanding the sustainability of public finances in light of economic conditions.
• Retail Sales Data (Friday): The retail sales data for October will be released on Friday. It will offer a key indicator of whether the strength seen in retail spending during Q3 has persisted into Q4. Retail sales grew by 1% in Q3, with monthly increases averaging 0.8% after a sluggish first half. A strong retail sales report would indicate continued consumer confidence and demand.

Bank of England Rate Cut Speculation

Speculation around a December rate cut from the Bank of England has been significantly reduced. The inflation data this week, along with other reports leading up to the BOE’s meeting in December, are unlikely to sway the market’s expectations. The base effect, with last year’s CPI flat in October and down by 0.2% in November 2023, suggests that the year-over-year CPI could return to or slightly exceed the 2% target by the time of the BOE’s December 19 meeting.

• Core Inflation: The core CPI stood at 3.2% in September, with consumer service prices up 4.9% year-over-year.
• Retail Sales: The retail sales report will provide an early gauge of consumer behaviour in Q4, potentially influencing the BOE’s policy stance.

GBP/USD Outlook

Sterling has struggled to maintain an upward trend, falling for the past six sessions. Since the end of September, it has depreciated nearly 6%, with more than half of that decline occurring post-U.S. elections. The GBP/USD has breached the June-July low near $1.2615 and briefly traded below $1.2600.

• Support Levels: The next support levels are seen around $1.2450-$1.2500, with the year’s low near $1.2300 providing a further downside target.
• Resistance Levels: On the upside, the $1.2700-$1.2720 range remains the nearest resistance zone.

Key Points:

• Inflation: The U.K.’s inflation is expected to rise above 2% in October, driven by energy price cap increases.
• Economic Data: Retail sales, public sector finance, and inflation data will all play key roles in shaping market sentiment and the BOE’s policy outlook.
• GBP Outlook: The British pound has been under pressure, with technical support levels near $1.2450-$1.2500 and resistance around $1.2700