USD rebound extends into a third week

USD: China stimulus, Middle East risks & UK labour market in focus

The major FX rates have remained relatively stable during the Asian trading session after the dollar index extended its recent rebound above the 103.00-level yesterday. The biggest mover overnight has been the Chinese renminbi which has weakened further following the China’s fiscal policy update at the weekend that fell short of lofty market expectations. The lack of details over fiscal stimulus plans has cast doubt on policymakers’ ability to boost growth. The Chinese media outlook Caixin has reported overnight that the government may raise CNY6 trillion from ultra-long special government bonds over the next three years. The funds will reportedly be used to help local governments relieve their burden from off-balance sheet debt. It follows comments from Finance Minister Lan Fo’an over the week indicating that there will be a one-off effort to replace local government’s hidden debt and that the program will be the “largest in recent years”. However, the measures announced so far have failed to fully meet market expectations that were looking for bigger fresh stimulus. The scaling back of optimism over China’s growth outlook is encouraging a stronger US dollar. 

The other big market mover overnight has been the price of oil with Brent falling back below USD75/barrel as it moves further below the recent high of USD81.16/barrel. The correction lower for the price of oil has been driven by a report in the Washington Post claiming that Israeli Prime Minister Netanyahu has told the Biden administration he is willing to strike military rather than oil or nuclear facilities in Iran according to two officials familiar with the matter. An official familiar with the matter also stated that retaliatory action would be calibrated to avoid the perception of “political interference in the US elections” signalling Netanyahu’s understanding that the scope of the Israeli strike has the potential to reshape the presidential race. The developments have contributed to the Norwegian krone underperforming at the start of this week.        

The main economic data release at the start of the European trading session has been the latest UK labour market report although the immediate impact has been limited. The report revealed further evidence that wage growth is continuing to slow from elevated levels. Average weekly earnings slowed to 3.8% 3M/%YoY in August and the ex-bonus measure to 4.9%. Similarly, the median pay measure also slowed to an annual rate of 5.3% in September after the monthly increase in August was fully reversed. In contrast, the BoE is likely to place less weight on the drop in the unemployment by 0.1 point to 4.0% in August. Slowing wage growth should encourage the BoE to lower rates again at their next policy meeting in November. Another 25bps BoE rate cut is almost fully priced for November. It remains more finely balanced as to whether the BoE will sped up the pace of rate cuts by delivering a back-to-back cut in December.        

WAGE GROWTH CONTINUES TO SLOW IN UK

Source: Bloomberg, Macrobond & MUFG GMR

EM FX: Headwinds building for EM FX ahead of US election   

Emerging market currencies have on the whole continued to correct lower against the USD over the past week. The worst performing emerging market currencies have been the BRL (-1.9% vs. USD), PHP (-1.7%), ZAR (-1.4%) and CNY (-1.4%). On the other hand, the IDR (+0.7% vs. USD), and THB have outperformed. After failing to break below support at the 5.4000-level, USD/BRL has risen back up towards recent highs at closer to the 5.6000-level. The BRL sell-off has extended since the end of last week reinforced by comments from President Lula that have re-heightened investor concerns over the government’s fiscal plans. President Lula stated that he wants bigger income tax exemptions beyond his existing pledge for workers with salaries of up BRL5k. Finance Minister Haddad has attempted to reassure market participants by stating that income tax reform will be fiscally “neutral”.

On top of the domestic policy concerns, the BRL has been undermined alongside other commodity-related emerging market currencies and Asian currencies by some initial disappointment over China’s fiscal policy plans. While domestic policymakers in China are clearly moving to provide more support for growth in China, the lack of details for further fiscal stimulus only adds to uncertainty over how effective upcoming policy changes will prove to be at lifting growth. For the rest of this year, the government will mainly focus on supporting growth through fully utilizing current budgeted funds and has signalled there is “relatively large room” to increase deficits and debt to support growth next year. The government will step up efforts to address two of the main drags on growth which have been weakness in the housing market and local government debt problems. It leaves market participants waiting for the announcement of further policy steps heading into next year. The fiscal policy update on its own is not sufficient to reverse the current USD rebound.           

The USD has continued to strengthen even as US yields have lost some upward momentum over the past week especially at the short-end of the curve. It highlights that market participants have already moved to price in a slower pace of Fed rate cuts through the rest of this year (25bps in November and December). Yields at the longer end of the curve have continued to move higher alongside the USD driven in part by the pricing in of a larger risk premium to reflect the rising probability of Donald Trump winning re-election in November. According to Polymarket, the probability of Trump winning has risen up to 55% which is the highest since early August, and he is  now leading narrowly on average in the six out of seven the key battleground states. A development that continues to pose downside risks for EM currencies related to China. Please see our latest EM EMEA Weekly (click here) for more details.

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
FR	08:45	French CPI NSA (YoY)	Sep	--	1.20%	!
EC	09:00	ECB Bank Lending Survey	--	--	--	!
GE	10:00	German ZEW Economic Sentiment	Oct	10.2	3.6	!!
EC	10:00	Industrial Production (MoM)	Aug	1.8%	-0.3%	!!
CA	13:30	CPI (YoY)	Sep	1.8%	2.0%	!
US	16:30	FOMC Member Daly Speaks	--	--	--	!!
US	18:05	FOMC Member Kugler Speaks	--	--	--	!
US	19:00	Federal Budget Balance	Sep	61.0B	-380.0B	!!
NZ	22:45	CPI (YoY)	Q3	2.2%	3.3%	!!

Source: Bloomberg