US yields remain elevated, providing USD support

USD: Middle East and ECB in focus in week ahead

The US dollar remains broadly stable in the foreign exchange market at the start of the week with no escalation of violence in the Middle East helping to contain equity market declines in Asia. Asian equity markets are generally lower in part on Friday’s US move with the S&P 500 falling 1.3%. The reduced fears of a broadening of the conflict in the Middle East with Israel holding off on a ground invasion is helping contain financial market risk aversion. The S&P future is up 0.3% and crude oil prices are down over 1%. The FX highlight perhaps so far today was the break above the 150-level for USD/JPY but again the move higher was brief, hitting 150.11 before selling quickly came in, possibly algo or option-related, taking USD/JPY back below. A notable macro-catalyst will be required for the market to have confidence buying at these levels.

If the geopolitical landscape remains as it is, financial market participants will likely revert to the key events of this week – the ECB policy announcement on Thursday and the flow of economic data from the US that will be key for the moves in the UST bond market. The 10-year yield remains close to the 5.00% level and hence risk appetite will likely remain fragile given the challenge for risk assets on a further move higher in US yields.

Our FX Weekly (here) from Friday covers the ECB policy meeting this week and with the key policy rate likely to be kept unchanged, the focus of the ECB is likely going to start shifting to balance sheet policy. The current pace of balance sheet shrinkage based on current policy guidance means around EUR 900bn of shrinkage through to the end of next year through the full maturity of all remaining TLTROs (EUR 498.5bn) and maturing securities from the APP, assuming the average monthly pace over the next 12mths persists through to the end of 2024.

We doubt there will be any formal change in balance sheet policy agreed at this meeting but President Lagarde may signal that a discussion took place which would increase speculation of a possible announcement in December.

Q3 GDP from the US will also be released this week and the rate of growth is expected to accelerate from the 2.1% Q/Q SAAR in Q2 to 4.1% in Q3. With a notable slowdown in GDP growth expected in Q4 a figure closer to 5.0% would likely be needed to prompt a notable move higher for yields and the dollar. A bigger downside risk for EUR might be a signal of faster balance sheet shrinkage in 2024 and criticism of Italy’s recent fiscal slippage with a message that TPI will not be used to provide shelter for inappropriate fiscal policies.

ECB BALANCE SHEET POLICY – IS SHRINKAGE PLANS FAST ENOUGH?

Source: Bloomberg, Macrobond & MUFG GMR

USD: The Fed seems more mindful of impending slowdown

UST bond yields fell notably at the end of last week and in part certainly reflected investors reduced appetite for risk over the weekend given the geopolitical uncertainties in the Middle East. Hence, this has reversed somewhat today. After closing at a cyclical high of 4.99% last Thursday, the 10-year yield is only marginally below that level and risks remain skewed to the upside at present.

But the macro-economic risks do appear to be also shifting a little. For sure, there is little evidence of that in much of the official data releases, two recent examples being the initial claims reading last week falling below the 200k reading and the very strong retail sales data for September.

But like all central banks, information gathered for making monetary policy decisions also involves “ears-to-the-ground” type information through certain established channels that provides more timely, higher frequency data to help central bankers spot turning points in the economic cycle. We may be at or approaching that type of moment in the US and the comments from Philadelphia Fed President Harker on Friday were interesting in that context. Harker earlier this year, like most FOMC members was a big supporter of rate hikes but his tone started to shift over the summer and more recently has indicated support for pausing. On Friday he was a bit more explicit in suggesting enough has been done and a slowdown is imminent by stating he was “hearing the economy is softening faster than thought” and that he was “hearing inflation was easing faster than thought”.

This would be through contacts in Philadelphia. The Beige Book, released last week, for the upcoming FOMC meeting tends not to get too much attention but our analysis of the text contained in the report did reveal a more pessimistic overview than in previous reports. Our FX Weekly (here) published on Friday outlines our analysis but the key takeaway was that after consecutive improvements in the sentiment analysis through the summer, last week’s Beige Book worsened. Drilling further into the source of this worsening, we saw that text related to the consumer and consumption were the main source of the deterioration.

We certainly will need to wait to see some evidence in the official data, which may take time, but our text sentiment analysis of the Beige Book, the comments from Harker on Friday and Powell’s more cautious tone on the restrictiveness of the monetary stance make us more confident that the flow of macro data should start to turn more in favour of some correction lower in yields that would mark a turn for the dollar too.  

NATURAL LANGUAGE SENTIMENT WORST SNCE ONSET OF PENDEMIC IN 2020

Source: Macrobond & Bloomberg

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
CH	11:00	FDI	--	--	-5.10%	!
CA	13:30	Core Retail Sales (MoM)	Aug	-0.1%	1.0%	!!
CA	13:30	Retail Sales (MoM)	Aug	-0.3%	0.3%	!!
EC	13:30	ECB McCaul Speaks	--	--	--	!!
US	14:00	FOMC Member Harker Speaks	--	--	--	!!
US	17:15	FOMC Member Mester Speaks	--	--	--	!!

 

Source: Bloomberg