No Rest for the Weary: The Week Ahead

In Volcker's days, when he used money supply to justify tightening monetary policy despite high unemployment, the money supply was released while markets were open, and it was The report. Later, by the mid-1980s, leading up to the Plaza Agreement, the deterioration of the US monthly trade balance was critical. It became The report. For several years now, the monthly jobs report superseded it. It is the first hard data for a new month and often sets the tone for the other economic reports, and it tends to be volatile, which in proper doses, the market likes.

Now It is CPI. There is no trade-off between the Fed's two mandates now. The labor market is still strong. The September unemployment rate fell back to the cyclical low of 3.5%. Weekly initial jobless claims fell to five-month lows at the end of September, and the four-week moving average (207k) was the lowest since May. The JOLTS data showed some softening of the labor market, but on balance, it appears stronger than the Fed thinks is consistent with price stability. And price pressures remain elevated, and that will be the main message from the September CPI on October 13.

The median forecast in Bloomberg's survey is for a 0.2% increase on the month. This will replace the 0.4% increase in September last year and allow the year-over-year rate to fall toward 8.1% from 8.3%. As a result, the three-month annualized rate (Q3) would be about 1.2% from slightly more than 10% in Q2 and Q1. That is a meaningful change.

However, the core rate is proving far stickier. Non-energy services, like shelter and medical services, have risen 3.5% year-over-year in August. The core measure is expected to have increased by 0.5% in September. It rose by 0.3% in September 2021. The base effect could lift the year-over-year rate to 6.5% from 6.3%. This would match the year's high seen in March and challenge claims that inflation peaked.

Encouraged by the Fed's economic projections and a view of the Fed's reaction function, the market has positioned for a 75 bp hike at the November 2 FOMC meeting. It had been expected to be the last of the 75 bp moves, but the jobs report opened the door a little to another 75 bp move in December. The market is considering a higher terminal rate of 4.75% instead of 4.50%. That said, the market still suspects the Fed may cut in Q4 23. The implied yield of the December 2023 Fed funds futures contract is about 14 below the September 2023 contract.  

Some economists have called on the Fed to adjust its monetary policy given the collateral damage it is said to be causing. Some point to it as "exporting inflation," and the systemic risks illustrated by the BOE's recent reversal to buy bonds rather than sell them, BOJ intervention to support the yen for the first time since 1998, and record South Korean intervention in Q2 to support the won. Europe's energy shock is being exacerbated by exchange rate developments at a crucial time. Sri Lanka, Pakistan, and Argentina need IMF assistance. 

It is part of the FOMC's boilerplate statement after a meeting that among the wide range of information that officials will consider are "international developments." The Fed's charter is provided by the US Congress. The purpose of following international developments is not out of some sense of altruism and concern, but at a genuine level, how those developments affect us, as in the US. South Korea needs to request a new swap line with the US, and the ECB and the BOE, for example, do not because the ECB and the BOE are seen as important centers of dollar transactions and have been granted a permanent facility. Press reports of Treasury Secretary Yellen's discussion with South Korea's Deputy Prime Minister Kyung-ho suggest the US could offer a temporary swap line to South Korea and possibly more countries if the financial tensions persist.

Ultimately, domestic variables are more salient. When Fed Chair Powell explained to the American people that getting inflation down requires some pain, it is less now than it could be later if inflation expectations are embedded into consumer and business practices. Isn't that the same message the US would give to its trading partners and countries and companies that have borrowed dollars? It seems that re-pricing assets post-Covid and in light of Russia's invasion of Ukraine (and the policy response) was not going to be a linear process. Several countries, like the UK, Norway, and New Zealand among the high-income countries, and Brazil, Mexico, and Chile, for example, among emerging market economies, began raising rates several months before the US did. Some even moved before the Fed's pivot in September 2021. Many seem more critical of the Fed than other central banks, some enjoying lower real interest rates than the US. 

If we acknowledge the Fed's right to pursue a monetary policy based on its domestic economic priorities, shouldn't other countries enact policies that are consistent with their national interests? The Federal Reserve did not "snub" Argentine, Sri Lanka, Pakistan, or Europe as some economists would have it by tightening monetary policy with inflation running 8-9%. Has OPEC+ really snubbed the US with its announced 2 mln barrel a day cut in output (which effectively might only be half as much, given many members were unable to fulfill higher quotas)?   

China returns from its Golden Week holiday. Playing a little catch-up, mainland stocks and the yuan may open firmly. There are several high-profile economic reports in the coming days. The lending figures will be watched partly as a type of fiscal stimulus where the state-owned banks are encouraged to boost lending and draw from future quotas. September aggregate lending figures are expected to be around the recent average (the three-month average is ~CNY2.8 trillion. Reopening some areas, like Chengdu, from the Covid-related lockdowns may have helped lift the trade surplus. On a year-over-year basis, exports are forecast to have risen by 4% (7.1% in August). With the US and Europe's diesel supplies squeezed, China's refiners may seize the opportunity and boost their production. Imports are expected to be flat year-over-year, which would match the April reading, and was the lowest since the outright decline in August 2020.

Last year, when China's PPI was soaring, some economists tried linking it to US consumer prices. That always seemed a stretch to us. First, Americans buy more services typically than goods. Second, as we know, the CPI and PCE deflator is a basket of goods and services with particular weights rather than including everything. Third, there are so many intermediaries that the price of a good that the US consumer buyers could be 50% higher than the import price. At the risk of oversimplifying, consider transportation, storage, marketing, and costs incurred domestically. In any event, China's PPI has collapsed from a peak of 13.5% last October to 2.3% in August. The median forecast in Bloomberg's survey puts it at 1.1% in September.

China's own CPI does not seem to move in tandem with the PPI. Its CPI finished last year at 1.5%. In the June-August period, it has been 2.5%-2.7%. The median forecast expects it to rise to 2.8% in September, which would be the highest in nearly two-and-a-half years. Of note, Premier Li, who is not likely to get a third term as President Xi will, suggested in July that provided it stays below 3.5%, CPI need not be a problem. Still, China's consumer inflation is essentially a food and energy story. The core rate was steady in August at 0.8%. Despite this low core inflation and the poor economic impulses, officials seem reluctant to cut interest rates further. The medium-term lending facility rate stands at 2.75%. It was cut by 10 bp in August and in January.

Turning to the eurozone, as we have noted, the terms-of-trade shock spurred a dramatic shift in the trade balance. September trade figures are reported on October 14. In the first eight months of 2021, the eurozone recorded a trade surplus of about 124 bln euros. In the January-August period this year, it recorded a trade deficit of 185 bln euros. Other things being equal, which they are not, the deterioration would be expected to be negative for the euro. The euro has depreciated this year by around 13.5% against the dollar, but it is off about 3.0% on a trade-weighted basis. Because of this divergence, some argue that the euro still needs to fall much further. Yet, if the deficit is primarily the energy story, then maybe not. Its decline against the dollar is so extreme that the OECD's purchasing power parity model sees the euro nearly 44% undervalued.

Italy's new Chamber of Deputies will sit for the first time on October 13. The Senate is expected to hold its first session around then as well. Shortly thereafter, President Mattarella is expected to formally grant the Brothers of Italy to put together a new government. Italy's 10-year yield is elevated above 4.50%. The mid-June scare had seen it spike above 4%, helping to spur the launch of the new Transmission Protection Instrument. In mid-June, the two-year yield poked above 2%. It reached 3.40% in late September before falling below 2.50% in the first part of last week. However, it bounced back strongly and finished the week around 3.0%. Just as important as the absolute level is the spread over Germany. The 10-year Italian premium is above 250 bp.  It is above the 2020 extreme and the most since mid-2019. The two-year premium did not surpass the 2020 high (230 bp), but it made a marginal new high for the year in late September (132 bp). It settled last week at 125 bp.

Lastly, the UK reports on the labor market and August GDP and details. With a general acceptance that the economy is contracting or on the verge, the market's focus is elsewhere. The BOE is critical. The average daily turnover in the UK Gilt market is around GBP12 bln. So, the market paid attention when the BOE said it may buy as much as GBP5 bln a day. However, more than halfway through the emergency program, the BOE has bought about GBP5 bln. The BOE is not simply trying to prop up the market. The 30-year Gilt yield rose to almost 5.15% on September 28, more than a 150 bp increase in five sessions. The BOE's announcement drove the back to nearly 3.60% on October 3. The yield has risen back, partly amid talk that pension funds and insurance companies may be selling to raise a cushion so when the BOE is no longer there, it has some padding. It reached about the mid-point of that yield range near 4.40% late last week.

The most likely scenario is probably not that on October 14, the BOE spokesperson says, "That's it, folks. We're done," drops the mike, and walks away. Partly, it may have tied its shoes together by saying that its bond sales, unwinding some of QE, and the more passive approach of not fully reinvesting maturing proceeds, would be postponed from the start of the month to the end of it. In its attempt to distinguish between QE-buying and stability-buying, the BOE kept these recent purchases in a different account and indicated it would sell the newly acquired bonds quickly once the markets were deemed sufficiently stable. The Financial Policy Committee meets on October 12, from which may come an announcement about the BOE's intentions. It does not need a new facility. Should the situation require, it can always backstop, but a new facility might reassure other investors and boost the chances of not having to use it.

The hawkish rhetoric by the Bank of England after Chancellor Kwarteng's mini-budget fanned speculation of an exceptionally large hike of 150 bp when the MPC next met on November 3. However, as the sterling stabilized, the swaps market is less convinced and now seems to be wrestling with a 100-125 bp move. Sterling is off about 17.5% against the dollar this year, but it has depreciated a more modest 7.5% on a trade-weighted basis. Sterling jumped from that record low set in Asia near $1.0350 on September 26 and stalled last week in front of $1.15. However, it does not look as if sentiment has changed, and this can be seen in the options market with the large premium for puts over calls. A move into the $1.08-$1.10 area may still be consistent with a technical correction, but a break could be ominous. 

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