10/08/2024 Market Analysis

Week Ahead: Price Action vs. Surprises in U.S. CPI

A deluge of economic data is expected to shape market sentiment in the coming days. Investors will closely scrutinise key indicators from the United States, Europe, and Asia.

Following recent weak U.S. jobs data, market participants will be keenly focused on inflation figures and other economic metrics for signs of a potential recession. Meanwhile, in Europe, a raft of U.K. data, including inflation, is due alongside a monetary policy decision from Norway.

The Asia Pacific region will also be in the spotlight, with investors awaiting economic growth estimates from Japan and a policy decision from the Reserve Bank of New Zealand. Additionally, China’s economic indicators are expected to influence global market dynamics.

United States of America

U.S. Economic Data and Fed Policy Expectations

Recent weaker labour market data have created a noticeable gap between Federal Reserve signals and market expectations. The market is now pricing in slightly more than 100 basis points of easing over the next three FOMC meetings, reflecting a more aggressive stance than earlier this year. Despite this, the bar for a September rate cut appears low, and the July Consumer Price Index (CPI) is unlikely to hinder this move. A 0.2% increase in the headline CPI would keep the year-over-year rate at 3.0%, though the three-month annualized rate would fall to about 0.4%, down from 0.8% in the previous three months. The six-month annualized rate would be around 2.4%. Similarly, a 0.2% rise in the core CPI would maintain a 3.3% year-over-year increase, but the three-month and six-month annualized rates would decrease to 2.0% and 3.2%, respectively.

PPI, Retail Sales and Industrial Production

Producer Price Index (PPI) data, due August 13, will provide additional context, although it is not typically a major market mover. However, given its role in forecasting the Personal Consumption Expenditures (PCE) deflator, which the Fed targets, it may attract attention. Both headline and core PPI are expected to rise by 0.2%, with the year-over-year headline rate falling to approximately 2.2% from 2.6%, and core PPI decreasing to 2.6% from 3.0%. Retail sales, industrial production, and housing starts/permits for July will also be reported. Retail sales are anticipated to slow after accounting for the recent uptick in auto sales, with consumer pullback expected this quarter. Industrial production is projected to decelerate after a 0.6% rise in June, while housing starts may see a slight increase, marking the first back-to-back gain this year. The US TIC data will be closely watched following record divestment by Chinese investors in May. Additionally, the University of Michigan’s consumer confidence survey has fallen for four consecutive months, reaching its lowest point since last November at 66.4.

Dollar Index

The Dollar Index (DXY) fell to seven-month lows around 102.15 at the start of last week but has since risen consistently, reaching approximately 103.40. The near-term corrective potential is expected to extend into the 103.80-104.20 range. While a correction to the market’s possibly exaggerated expectations of Fed easing might support the DXY, evidence of slowing economic activity could limit the upside potential.

Key Data and Treasury Auctions

The upcoming week’s U.S. economic data will be crucial in determining the Fed’s future actions. CPI inflation and retail sales figures, set for release on Wednesday and Thursday respectively, will be closely scrutinized. The PPI data on Tuesday will provide insights into pipeline inflationary pressures. The July University of Michigan consumer sentiment survey on Friday will offer a snapshot of current economic health. Additionally, the U.S. Treasury will auction $70 billion in 26-week Treasury bills on Monday and $75 billion in 42-day bills on Tuesday.

Key Points:

• Market Expectations: The market anticipates over 100 basis points of Fed easing in the next three meetings, though this may be viewed as aggressive.
• Inflation Data: July CPI and PPI data are expected to show modest increases, with a potential decline in inflationary pressures.
• Economic Activity: Retail sales, industrial production, and housing starts data will provide further insight into economic trends and consumer behaviour.
• Dollar Index: Recent fluctuations in the Dollar Index reflect adjustments to market expectations and economic data.

Australia

Reserve Bank of Australia’s Hawkish Hold and Market Reactions

The Reserve Bank of Australia (RBA) recently opted for a hawkish hold on interest rates, yet the market remains unconvinced by the central bank’s stance. The futures market has now priced in a slightly higher likelihood of a rate cut by the end of the year, with the probability increasing from 80% to nearly 100% over the past week. The upcoming July employment report, set for release on August 15, is unlikely to significantly alter these views. Notably, Australia added slightly more full-time positions in the first half of 2024 compared to the same period in 2023, with the unemployment rate expected to remain steady at 4.1%, up from 3.8% in July 2023.

Australian Dollar’s Trading and Momentum

The Australian dollar exhibited mixed trading behaviour, fluctuating within the previous week’s range but ultimately settling without breaking out. The currency encountered resistance around $0.6600, a key level that marks the lower end of its prior trading range and where the 20- and 200-day moving averages converge. This level also represents the 61.8% retracement of the Aussie’s decline from the July 11 high of approximately $0.6800 to last Monday’s panic low of $0.6350. Despite a lacklustre performance before the weekend, momentum indicators for the Australian dollar have turned higher, suggesting potential upward movement.

Key Points:

• RBA’s Hawkish Hold: The Reserve Bank of Australia’s decision to maintain rates has not swayed market expectations, with a higher probability of a rate cut now priced in.
• Employment Data: July’s employment report is anticipated to show a steady unemployment rate of 4.1%, with slight gains in full-time positions compared to the first half of 2023.
• Australian Dollar Trading: The Aussie struggled around $0.6600, facing technical resistance at a key retracement level, though momentum indicators suggest a possible upward shift.

Canada

Canada’s Economic Outlook and Market Expectations

Canada’s economic calendar is relatively light in the coming days, with key highlights including July housing starts, existing home sales, and June portfolio flows. Despite the lack of high-frequency data, an important shift in market expectations may be underway, potentially allowing the Canadian dollar to establish a low point near levels seen in 2022 and 2023. The peak of policy divergence expectations appears to be behind us, with the swaps market now pricing in slightly more than 75 basis points of Canadian rate cuts for the remainder of the year. This shift in expectations follows a similar trend in the U.S., where the swaps market was pricing nearly 75 basis points of Federal Reserve cuts before the release of disappointing U.S. jobs data. The U.S. two-year premium over Canada peaked in early June at nearly 90 basis points, the highest since 2005, but has since decreased to around 70 basis points. Despite these shifts, the correlation between changes in the exchange rate and the two-year interest rate differential remains moderate, at 0.2-0.3 over the past 30 and 60 days.

Canadian Dollar Recovery and Technical Analysis

Amid a dramatic loss of risk appetite early last week, the U.S. dollar surged to a two-year high near CAD 1.3945. However, as markets began to stabilize, the Canadian dollar recovered, ending the week near its best level in almost three weeks. It begins the new week with a six-day advance, matching the longest streak of the year. On the weekly bar charts, the greenback posted a potential key reversal, trading on both sides of the previous week’s range before settling below the prior week’s low. At CAD 1.3725, the U.S. dollar encountered resistance at the 61.8% retracement of the rally from the July 11 low, just below CAD 1.36 and the 200-day moving average. A break of CAD 1.3700 could target the CAD 1.3660 area. Additionally, the five-day moving average crossed below the 20-day moving average before the weekend, and momentum indicators are trending lower, suggesting further downward pressure on the U.S. dollar.

Key Points:

• Economic Calendar: Limited high-frequency data releases in Canada, with focus on July housing starts, existing home sales, and June portfolio flows.
• Market Expectations: Shifts in policy divergence expectations may allow the Canadian dollar to find a low near past levels, with over 75 basis points of rate cuts priced in for the year.
• Exchange Rate Correlations: Moderate correlations with the two-year interest rate differential, WTI, the S&P 500, and the Dollar Index suggest a complex interplay of factors influencing the Canadian dollar.
• Technical Analysis: The U.S. dollar’s potential key reversal and the Canadian dollar’s recent recovery highlight critical technical levels, with a break of CAD 1.3700 potentially leading to further gains for the loonie.

Europe

Eurozone Economic Outlook Amidst Signs of Stagnation

The upcoming release of the first estimate for Q2 GDP and June’s industrial production figures on Wednesday will provide critical insights into the eurozone’s economic trajectory. These figures come at a time when recent data, including purchasing managers’ surveys, indicate that the eurozone’s recovery may be stalling. The persistent decline in new orders is a significant downside risk, coupled with fresh concerns about market volatility and a weakening U.S. economy.

German Economic Sentiment and GDP Projections

Germany, the largest economy in the eurozone, continues to face challenges. The German ZEW sentiment survey for August, due on Tuesday, is expected to shed light on the current state of the economy. July’s survey saw a decrease in the expectations component for the first time since July 2023, while the current assessment improved but remained negative. The preliminary forecast for Germany’s Q3 GDP is 0.3%, which could mark the strongest growth since Q3 2022, despite the recent unexpected contraction in Q2.

Euro Consolidation and Market Sentiment

The euro has experienced significant price action, particularly following the U.S. jobs report on August 2. Over the past four sessions, the euro has been consolidating within the $1.0880-$1.0960 range. This consolidation phase seems to continue as markets await further developments. There is also the potential for the U.S. two-year premium over Germany to widen if markets reassess the likelihood of a 50 basis point rate cut by the Federal Reserve in September.

Key Points:

• Q2 GDP and Industrial Production: Critical eurozone data releases are expected on Wednesday, providing insight into the economic outlook.
• Downside Risks: Recent surveys suggest a decline in new orders, indicating potential risks to the eurozone’s recovery.
• German ZEW Survey: The August ZEW sentiment survey will offer updated insights into Germany’s economic health.
• German Q3 GDP Forecast: Preliminary projections suggest 0.3% growth, potentially the best since Q3 2022.
• Market Expectations: The market is currently pricing significant rate cuts by the ECB, with a focus on potential moves in September.

Japan

Japan’s Economic Outlook and Yen Volatility

The performance of the yen and Japanese equities remains a central focus this week, especially given the light economic agenda in the coming days. Japan is set to release its first estimate of Q2 GDP early Thursday. The economy, which contracted at an annualized rate of 2.9% in Q1 due to disruptions from a natural disaster and an auto industry scandal, is expected to have rebounded in Q2. However, the recovery may not be sufficient to fully offset the losses from Q1. Economists project a 2.5% expansion in Q2, with a notable recovery in consumer spending after four quarters of contraction. Additionally, net exports and private investment are expected to show improvement, with private investment likely recovering from the 1.6% decline seen in Q1. The GDP deflator, which peaked at 5.2% in Q3 2023, has been on a downward trend, and the forecast for Q2 is a 2.5% year-over-year increase, the lowest since Q1 2023.

Yen Carry Trades and Market Dynamics

The recent dramatic recovery of the yen and the sharp drop in the U.S. 10-year premium over Japan, which fell below 300 basis points for the first time in 15 months before rebounding to around 310 basis points, have drawn attention to portfolio capital flows. The latest Ministry of Finance data indicated that Japanese investors were net buyers of foreign stocks and bonds in the week ending August 2. The dollar, after bottoming near JPY 141.70 at the start of last week, rallied to JPY 147.90 midweek before consolidating. The extent of yen carry trades remains unclear, and their unwinding could have significant market implications. Japanese purchases of foreign assets appear more strategic, while foreign borrowing of yen to invest in higher-yielding assets seems more opportunistic and vulnerable to pressure. The current price action suggests that the recent shakeout may be concluding, with resistance likely in the JPY 148.00-JPY 148.45 area. However, a move below JPY 145.50 could signal that establishing a bottom will take more time.

Upcoming Economic Events and Market Impact

Japan’s Q2 GDP release on Thursday will be closely watched for signs of economic strength, which could justify any future policy decisions by the central bank, particularly regarding interest rates. This data release comes amidst significant yen volatility and fluctuations in the stock market. Economists surveyed predict a 2.2% annualized growth for the April-June quarter. Market participants will also pay close attention to investor demand for upcoming government bond auctions, including the Ministry of Finance’s 2.3 trillion yen five-year sovereign note auction on Wednesday and the 10-year inflation-indexed bond auction on Friday. These auctions are especially critical given the recent sharp yield and price swings in Japanese Government Bonds (JGBs).

Key Points:

• Q2 GDP Estimate: Japan is expected to report a 2.5% annualized growth in Q2, with a recovery in consumer spending and private investment.
• Yen and U.S. Premium: The yen’s dramatic recovery and the narrowing U.S. 10-year premium over Japan have heightened focus on portfolio capital flows.
• Market Dynamics: Yen carry trades and foreign borrowing remains significant factors, with technical resistance levels observed at JPY 148.00-JPY 148.45.
• Bond Auctions: Investor interest in the upcoming five-year and 10-year bond auctions will be critical, given the recent volatility in JGBs.

New Zealand

Reserve Bank of New Zealand’s Upcoming Meeting

The Reserve Bank of New Zealand (RBNZ) is set to meet on August 14, with the swaps market pricing in a more than 70% chance of a rate cut. Expectations for 50 basis points cut at the October 9 meeting are fully discounted, and with three RBNZ meetings remaining this year, the market has factored in 93 basis points of easing, up from about 77 basis points at the end of July.

New Zealand Dollar Performance

The New Zealand dollar recently recovered from a marginal new low for the year around $0.5850, rebounding to $0.6035 before the weekend. This recovery nearly achieved the 61.8% retracement of the decline from the July 8 high (~$0.6140). The 200-day moving average is approaching $0.6080. Similar to the Canadian dollar, the Kiwi has shown a potential key reversal on the weekly charts, with momentum indicators trending higher.

Key Points:

• RBNZ Meeting: Market anticipates a rate cut at the August 14 meeting, with further easing expected in upcoming RBNZ sessions.
• NZD Recovery: The New Zealand dollar has rebounded from yearly lows and is approaching key technical levels.
• Market Sentiment: The potential key reversal in the NZD and positive momentum indicators suggest a strengthening outlook for the currency.

United Kingdom

Bank of England’s Easing Cycle and Market Expectations

The Bank of England (BOE) initiated an easing cycle on August 1, with the swaps market pricing in an additional 50 basis points of cuts before the year’s end. Despite this, BOE Chief Economist Huw Pill voted against the cut, signaling caution about further reductions in the near term. The market reflects this uncertainty, showing less than a 50% chance of a cut at next month’s meeting. Upcoming economic data will significantly influence expectations, particularly the labor market update and Consumer Price Index (CPI) reports. Given that CPI fell by 0.4% in July 2023, the year-over-year rate is expected to rise from the 2.0% target seen in May and June. For Q2, the UK’s CPI rose at a 2.8% annualized pace, up from 2.4% in Q1. The labor market shows signs of slowing, with the claimant count increasing by nearly 100,000 in Q2, the highest since the early pandemic days, and moderating wage growth (5.7% year-over-year in May compared to 7.2% in May 2023). The UK’s Q2 GDP, due Thursday, is expected to slow to 0.3% quarter-over-quarter from 0.7% in Q1, but the BOE’s rate cut may diminish its market impact.

Sterling and Market Reactions

Sterling fell from a yearly high of $1.3045 on July 17 to $1.2665 on August 8. This decline appears to be exhausting, with sterling showing a potential key reversal on August 8 by falling to a one-month low before rallying to close above the previous session’s high. Follow-through buying has been limited, but momentum indicators suggest a potential turning point, with the five-day moving average levelling off. Resistance is seen around $1.2810-$1.2850, and then $1.2900. A break below $1.27 would be considered disappointing.

Upcoming Economic Reports

The upcoming week is crucial for U.K. data, following the BOE’s first rate cut in four years. Consumer-price inflation data for July, due Wednesday, will be key, particularly regarding its implications for future interest rate decisions. Annual CPI has remained at the BOE’s 2.0% target but is expected to edge higher due to base effects. Key focus areas will include changes in services and core inflation, as well as wage inflation, with U.K. jobs data set for release on Tuesday. Additional data will include the first estimate of Q2 GDP, industrial production, and trade figures for June on Thursday, and retail sales on Friday. Producer-price inflation for July will also be released alongside CPI data.

Market Insights

Economist forecasts that moderating inflation pressures, a slackening labour market, and a slowdown in GDP growth in the latter half of the year will likely lead the BOE to cut rates by an additional 25 basis points to 4.75% in November. A reduction in September seems unlikely unless market volatility resumes. Additionally, the U.K. Debt Management Office plans to sell a January 2038 gilt on Tuesday.

Key Points:

• BOE Easing Cycle: The BOE has begun an easing cycle, with market expectations for an additional 50 basis points of cuts this year, but further reductions may be cautious.
• Economic Data: Key upcoming reports include July CPI, labour market data, Q2 GDP, industrial production, and trade figures, which will influence rate expectations.
• Sterling Performance: Sterling has shown signs of a potential reversal, with resistance levels around $1.2810-$1.2900 and significant support below $1.27.
• Future Projections: Inflation moderation and economic slowdowns suggest further BOE rate cuts could occur in November, with current expectations for September cuts being cautious.