China PMI surveys & EZ inflation highlight risks to continued USD sell-off

USD: Weak China PMI surveys & PCE deflator report in focus

The US dollar has continued to trade close to recent lows during the Asian trading session. It has resulted in in USD/JPY falling back below the 147.00-level. The main economic data release overnight has been the release of the latest PMI surveys from China for November. The surveys revealed that business confidence has declined for the second consecutive month which is sending a cautionary signal over the strength of the economic recovery heading into year end. It follows stronger growth of +1.3%Q/Q in Q3 which provided encouragement that the stimulus measures announced over the summer would continue to support stronger growth in the second half of this year. The consensus forecast for GDP growth in China this year has risen over the past month from around 5.0% up to 5.2%. The PMI surveys though have signalled that the pick-up in growth could already be petering out. The composite PMI measure dropped to 50.4 in November which was the lowest level this year. It was mainly driven by a decline in the non-manufacturing survey which unexpectedly declined by 0.4 point to 50.2. According to the National Bureau of Statistics, a major drag was from the post-holiday cooling in travel and consumption-related businesses. The unexpected loss of growth momentum will keep pressure on policymakers in China to provide more stimulus to support growth. As we highlighted in one of our recent FX Weekly reports (click here), the ongoing growth concerns in China are one of the reasons why we are sceptical over  a repeat of the powerful Asia FX rally that took place at the same time late last year.

Weak growth outside of the US should help to prevent an even bigger US dollar sell-off in the near-term, and provide an offset to the negative impact to the US dollar from the ongoing dovish repricing of Fed policy expectations. The market has moved in recent days to price in earlier and deeper Fed rate cuts that triggered further US dollar selling. The first Fed rate cut is now fully priced in by May, and there is around 115bps of cuts priced in total by the end of next year. It follows comments from Fed Governor Waller indicating that the Fed would begin to consider cutting rates if inflation continues to slow over the next 3-5 months. The comments will place even more importance on the release of upcoming inflation reports including today’s PCE deflator report for October. After the softer than expected CPI and PPI reports for October, today’s PCE deflator report is similarly expected to reveal further evidence for slowing inflation. The Bloomberg consensus forecast is for the core PCE deflator to increase by 0.2%. It has increased on average by 0.2%M/M over the last four months to September compared to 0.3%M/M in the previous four month period.        

PMI SURVEYS CAST DOUBT ON STRENGTH OF RECOVERY 

Source: Bloomberg, Macrobond & MUFG GMR

EUR: Slowing inflation to encourage ECB to cut rates next year

The broad-based US dollar sell-off this month has helped to lift EUR/USD back up to the top the narrow 1.0500 to 1.1000 trading range that has been in place for most of this year.  While the pair briefly hit a year to date high of 1.1276 in July, the break above the 1.1000-level proved to be short-lived. The last time that levels above 1.1000 were recorded on a more sustained basis were prior to the outbreak of the Ukraine conflict in early 2022. The easing of the negative energy price shock in Europe triggered by the Ukraine conflict has helped to support the euro this year. Fears over the risk of another negative energy price shock triggered by heightened geopolitical risks in the Middle East relating to the conflict between Hamas and Israel briefly threatened to drag EUR/USD back below the bottom of the 1.0500 to 1.1000 trading in October, but have since eased. The price of oil has dropped back towards year to date lows reflecting in part more confidence amongst market participants that the conflict will remain bilateral and more recently has been encouraged by the temporary ceasefire between Hamas and Israel. After the recent adjustment higher for EUR/USD, the pair now appears better aligned with lower energy prices. 

At the same time, the recent adjustment higher for EUR/USD has been partially supported by the recent relative shift in monetary policy expectations between the ECB and Fed. Short-term yields have fallen by more than in the euro this month as market participants have moved to price in the Fed starting to cut rates next year ahead of the ECB. After the dovish comments from Fed Governor Waller this week, the 2-year US government bond yield has fallen by around 44bps this month compared to around 21bps in the euro-zone. Unlike Fed Governor Waller, ECB officials are not yet ready to indicate that they are willing to consider cutting rates if inflation continues to slow in the coming quarters. Nevertheless, the release of latest CPI report from Germany and Spain yesterday showing that inflation is continuing to slow alongside stagnating economic activity in the euro-zone has encouraged market participants to almost fully price in the first 25bps ECB rate cut by April. The macro developments are increasing the likelihood that the ECB could begin to cut rates ahead of the Fed next year posing downside risks for the euro in early 2024. It is one of the reasons why we remain cautious about forecasting further upside for EUR/USD above the 1.1000-level, although we acknowledge that there is strong seasonal bias for the USD to weaken further in December.  

CORE INFLATION IS NOW BEGINNING TO ROLL OVER

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
GE	08:55	German Unemployment	Nov	--	2.678M	!
US	10:00	OPEC Meeting	--	--	--	!!
EC	10:00	CPI (YoY)	Nov	2.7%	2.9%	!!!
EC	10:00	Unemployment Rate	Oct	6.5%	6.5%	!!
US	13:30	Initial Jobless Claims	--	220K	209K	!!!
CA	13:30	GDP (QoQ)	Q3	--	0.0%	!!
EC	13:30	ECB President Lagarde Speaks	--	--	--	!!
US	14:05	FOMC Member Williams Speaks	--	--	--	!!

 

Source: Bloomberg