USD: US CPI report & comments from Fed Chair Warsh in focus this week

The major foreign exchange rates have remained stable overnight with the dollar index continuing to trade close to year-to-date levels at just above the 102.00-level. The US dollar has strengthened recently on the back of negative developments overseas that have boosted its appeal even as market participants have pared back expectations for Fed rate hikes. After peaking at 4.96% on 29^th September, the 2-year US Treasury yield has dropped back by around 20bps. The recent run of softer US data (PCE deflator report for August and NFP report for September) alongside cautious comments over the need for another back-to-back hike from the Fed’s leadership have dampened expectations for another rate hike as soon as this month. The US rate market is currently pricing in around 5bps of Fed hikes for this month compared to around 12bps on 29^th September.

Market expectations for the Fed to stay on hold this month will be tested by the release on Wednesday of the latest US CPI report for September. The current consensus forecast is for headline inflation to pick-up to 3.6%, but the monthly rate of core inflation is expected to slow to 0.2%M/M. Unless there is a significant upside surprise for underlying inflation, we expect the Fed to leave rates on hold this month. It is likely to be only a temporary pause as the fed currently plans to hike rates again before the end of this year in December. At the end of week on Friday, Fed Chair Kevin Warsh is scheduled to hold a fireside chat with IMF managing director Kristalina Georgieva during the IMF Annual Meetings in Thailand. He hasn’t spoken publicly since the Fed’s last FOMC meeting in September when the Fed raised rates for the first time. His comments will be listened to closely to assess his current thinking on recent economic developments and policy ahead of this month’s FOMC meeting.

SPECULATORS ARE REBUILDING EURO SHORTS

Source: MUFG Research, Macrobond, Bloomberg

EUR: EU is pushing back against China trade disruption

The euro continues to trade close to recent lows at just above the 1.1200-level against the US dollar. Heightened investor concerns over the fiscal and political risks in the euro area continue to weigh heavily on the euro and government bonds in the region particularly in France (click here). The latest IMM report provided confirmation that leveraged funds have been rebuilding short euro positions over the last couple of weeks to 6^th October although they still below the year-to-date highs from the end of July. At the current juncture, there is no obvious positive catalyst that could trigger a reversal of bearish sentiment towards the euro leaving it vulnerable to further weakness heading into year-end.           

Unlike the euro, the Chinese renminbi has been holding up better against the US dollar even as it has strengthened broadly. USD/CNY hit a fresh year-to-date low at the end of last week at 6.6900. Upward momentum for the renminbi has been encouraged by the PBoC setting lower daily fixes for USD/CNY over the past month even as the dollar index has strengthened by around 4%. It has resulted in the renminbi hitting fresh year-to-date highs on a trade-weighted basis. The CFETS CNY index has strengthened by just over 2% from the lows in September and has extended its year-to-date gains closer to 6%. The price action continues to highlight that the Chinese policymakers remain comfortable for the renminbi to strengthen as downside risks to trade from Trump’s tariffs have eased.

China has been able to successful shift trade away from the US to other Asian countries and Europe. China’s widening trade surplus with Europe is now triggering more pushback. It has been reported over the weekend that China has agreed to curb exports of hybrid vehicles to the EU as part of a 16-point consensus on trade and investment. The EU has unveiled plans to cap imports of Chinese hybrid vehicles at 350k cars per year taking effect from1st December and will increase by 6%annually from the second year of application. By accepting the import cap, China may be hoping to reduce the risk of harsher trade sanctions in the future. EU leaders will reportedly meet on Thursday to decide whether to adopt a more forceful response to the surge in Chinese imports. Building unease over China’s record trade surplus will keep external pressure on Chinese policymakers to allow the renminbi to continue to strengthen gradually to limit the negative impact on trade.