USD: Housing data becoming more relevant

The rally in global equities yesterday pushed some high-beta currencies higher: in G10, the New Zealand dollar and Swedish krona had a good day. However, currency-specific stories overshadowed the risk-on environment. GBP fell as markets slowly digest the fiscal U-turn, Norway's krone and Canada's dollar suffered from their elevated exposure to oil prices, where the post-OPEC cuts rally seems to have run out of steam and sub-$90 levels are being explored again.

The trade-weighted dollar remains close to its highs, likely being shielded from the equity rally thanks to market expectations of a 75bp Federal Reserve rate hike in November, and a terminal rate priced at 4.90-4.95%. As long as the Fed retains its hawkish stance (we suspect well into 2023), dollar corrections should continue to prove short-lived.

Today’s US calendar includes housing starts and building permits data, which will provide hints of how much strain is being put on the housing market from sharply rising mortgage rates. As discussed earlier this week, it appears that most developed central bankers are accepting a contraction in house prices as a necessary evil in the process of fighting inflation. Given the elevated weighting of shelter in the US inflation basket, a (controlled) downturn in house prices would likely mean a faster slowdown in inflation in 2023, and this is good news for the Fed. It’s probably too early anyway to see a material impact on Fed rate expectations from the housing data.

The Fed will publish the Beige Book today, and there are a few speakers to keep an eye on: Neel Kashkari, Charles Evans and the arch-hawk James Bullard.

We expect a consolidation in the dollar around current levels, and retain a bullish view on the greenback into year-end.

Francesco Pesole

EUR: Domestic picture remains grim

EUR/USD has been stabilising in the 0.98-0.99 area after the rally from 0.9700, likely reflecting some positioning adjustments more than any change in the key drivers. Dollar strength remains the main hindrance to recovery in the pair, but the domestic picture is still far from looking appealing to investors. Despite a smaller-than-expected slump in the ZEW expectations index, the current situation survey plunged dramatically to -72.2 in October. These are levels last seen only in 2020 and 2009.

The easing in gas prices is likely preventing a return to the 0.9540 lows, but we think the next round of dollar appreciation will heavily test that support.

Today, the eurozone calendar includes the final CPI reading for September, as well as speeches by the ECB’s Francois Villeroy, Mario Centeno and Ignazio Visco.

Francesco Pesole

GBP: Austerity times?

In a matter of days, the UK government has shifted from a large and unfunded expansionary fiscal policy to measures clearly in the direction of fiscal rigour. Chancellor Jeremy Hunt’s policy U-turn earlier this week has paved the way for a radically different policy agenda, and many are now speculating on widespread budget cuts after government offices suggested further savings worth 15% of the budget may need to be found by the government. A key Conservative policy, the hike in state pensions in line with inflation, may be scrapped in what could be the start of a new period of austerity.

Just looking at what the government has already changed from the "mini" Budget, the implications for markets are very significant. Our UK economist argues that the U-turn in energy bills cap can add 3pp to inflation next year and should increase the size/length of the recession. We think the Bank of England will need to take this into account and will hike by 75bp rather than the 100bp expected by investors at the November meeting. To be sure, inflation hitting double-digits today (10.1%), with the core rate at 6.5%, makes any dovish surprise a harder sell.

Today, Prime Minister Liz Truss will face questions by MPs. There is growing speculation that she will be forced to leave soon due to the loss of credibility and opinion polls currently suggesting the main opposition party (Labour) holding a 35-point lead.

GBP/USD has found some tentative stability around 1.13-1.14 as 10-year Gilt yields edged back below 4.0% for the first time in nearly a month. Our rates team remains doubtful that sub-4% levels are sustainable and continues to see elevated risks of Gilt market fragility. A key question is whether the Bank of England will go ahead with planned Gilt sales from the start of November. Yesterday, a media report suggesting another delay in quantitative tightening was dismissed as “inaccurate” by the BoE.

We still struggle to see a return to 1.15+ levels in cable, as a combination of political instability, risks of a deeper recession and smaller rate hikes by the BoE along the path of fiscal rigour – along with a strong dollar - may more than offset the benefits of quieter debt-related concerns. It’s too early to dismiss a return to sub-1.10 levels.

Francesco Pesole

CAD: Inflation to stir rate expectations

The Canadian dollar suffered from a contraction in oil prices yesterday, as global demand fears appear to be overshadowing the tighter supply picture following the OPEC+ output cuts. Our commodities team still expects Brent to close the year in the $95-100/bbl range on the back of tighter supply, but downside risks are clearly mounting with global recession fears.

We still want to highlight how the Canadian dollar is in a good position to benefit from any recovery in risk sentiment (although that may only materialise from 1Q23 onwards), thanks to Canada’s limited exposure to the two major poles of geopolitical and economic risk: Russia and China. But growing uncertainty about global demand dynamics may further postpone any strong rebound in the loonie.

The Bank of Canada will announce policy next week, and we expect a moderation in the tightening pace to 50bp as the economy starts to show signs of slowing and inflation recently came in below expectations. Today, September CPI numbers will be published, and the consensus is centred around a slowdown in headline inflation from 7.0% to 6.7%. With markets currently pricing in 60bp ahead of next week’s meeting, any upside or downside surprise can definitely direct rate expectations towards 50bp or 75bp, and generate CAD volatility in both directions. In our view, the balance of risks appears slightly skewed to the upside for CAD today, but there is still room for USD/CAD appreciation (1.38-1.40) into year-end.

Francesco Pesole