US shutdown risk is avoided as downside risk for USD

USD: US avoids government shutdown amidst more evidence of slowing inflation

The US dollar has continued to rebound overnight after suffering a sharp sell-off at the end of last week. After hitting an intra-day low of 105.66 on Friday, the dollar index has risen back up to an intra-day high overnight at 106.32 although it remains below last week’s high from 27^th September at 106.84. The US dollar continues to be mainly driven by the US rate market which has exhibited similar volatility in recent trading sessions. The 10-year US Treasury yield hit a fresh cyclical high on 28^th September at 4.69% before falling back to a low of 4.51% on Friday, and has since climbed back up to 4.61%. The pick-up in US yields at the start of this week has been supported by the last-minute deal reached in Congress over the weekend to extend government financing and avoid a lockdown at the start of this month. The short-term financing bill will fund the government through until the middle of November. It has though just delayed resolving ongoing disputes over spending levels, aid to Ukraine and immigration policy that had threatened to cause the government to shutdown this month. Congress will now face a new deadline of 17^th November to agree on full-year  government funding levels. According to the WSJ, the House has passed four of the twelve overall full-year appropriation bills to fund the government, while the Senate has passed none. A more prolonged impasse risks triggering a 1% cut in discretionary spending in January under the terms of the of the debt ceiling deal enacted into law this spring which is an outcome the Democrats and many Republicans are eager to avoid. By passing the short-term funding bill, the US economy will avoid a modest short-term drag on growth that would have resulted from a government shutdown. The Fed will also have more clarity over the health of the economy in the coming months as economic data releases will no longer be disrupted. At the margin it would make it more likely that the Fed will hike rates again at the 1^st November FOMC meeting than if there had been a shutdown although that decision will be determined more by the incoming economic data.

The Fed will have been reassured by the release of the PCE deflator report on Friday that provided further evidence that inflation continues to slow more quickly than expected in the US. The core PCE deflator increased by just 0.1% in August. It was the third consecutive softer monthly reading. Over the last three months the core PCE deflator has increased by an annualized rate of 2.2% compared to 3.8% in the previous three months. It was the lowest reading since December 2020. The super core measure of inflation (PCE core services less housing) also slowed sharply as well in August when it increased by just 0.14% which was the lowest reading since November 2020. The report gives us more confidence that inflation will continue to slow back towards target in the year ahead, and should give the Fed room to consider cutting rates next year. In the near-term it supports our view that the Fed should refrain from delivering one last hike later this year. The US rate market is currently pricing in around 8bps of hikes by the November FOMC meeting and 13bps by December FOMC meeting. It would help to dampen the US dollar’s upward momentum heading into year-end if the Fed decides to keep rates on hold. The next key data release to reassess Fed rate hike expectations will be Friday’s non-farm payrolls report for September.           

CORE INFLATION SLOWDOWN IS UNDERWAY IN BOTH US & EZ

Source: Bloomberg, Macrobond & MUFG Research

EUR: China PMI surveys & sharply weaker euro-zone inflation in focus   

The main economic data releases over the weekend have been the China PMI surveys for September. The official PM surveys have provided another signal that business confidence is improving after the composite reading increased for the second consecutive month by 0.7 point to 52.0 in September. While it has moved further above the low from August at 51.1 in July, the average over the last three months at 51.5 remains below the average over the previous three months of 53.2. The tentative recovery in business confidence in recent months could encourage some optimism that policy stimulus is beginning to provide more support for growth heading into year end. However, the positive signals from the official PMI surveys have been partially offset overnight by the release of the weaker than expected Caixin PMI surveys that have been sending the opposite signal that business confidence has been weakening in recent months. Overall, the data flow from China has not been sufficient to significantly ease investor pessimism over the outlook for China’s economy required to trigger a more sustained rebound for the renminbi and China related currencies.

The weakening growth outlook for China has been one factor that has weighed on the euro over the summer alongside weak growth in Europe and the paring back of ECB rate hike expectations. Similar to in the US, there is building evidence that inflation is starting to slow more sharply in the euro-zone as well with a lag. The release of the latest CPI reports at the end of last week revealed that headline and core inflation both fell sharply to 4.3% and 4.5% respectively in September . The much lower core inflation print was driven mainly by a big downside surprise for services inflation that slowed to 4.7% in September down from 5.5% in August. The weaker inflation data will reinforce expectations for no further hikes from the ECB and casts doubt on whether the September hike was necessary with the euro-zone economy currently so weak as well. It leaves the euro vulnerable to further weakness in the near-term.                          

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	09:00	Manufacturing PMI	Sep	43.4	43.5	!!
UK	09:30	Manufacturing PMI	Sep	44.2	43.0	!!!
EC	10:00	Unemployment Rate	Aug	6.4%	6.4%	!!
US	15:00	Construction Spending (MoM)	Aug	0.5%	0.7%	!
US	15:00	ISM Manufacturing	Sep	47.9	47.6	!!
UK	16:00	BoE MPC Member Mann	--	--	--	!!
US	16:00	Fed Chair Powell Speaks	--	--	--	!!!
US	18:30	FOMC Member Williams Speaks	--	--	--	!!!

Source: Bloomberg