Calm Under Pressure

November 20, 2024
6 min read

Calm Under Pressure

  • Financial markets steadied after getting whipsawed yesterday on geopolitical uncertainty.
  • UK inflation heats up in October. GBP rallies as BOE seen pausing easing cycle.
  • The Atlanta Fed GDPNow model estimate for Q4 US real GDP growth was revised a tick higher.

USD steadied after getting whipsawed yesterday on geopolitical uncertainty. Ukraine made its first tactical ballistic missile strike within Russian territory yesterday, raising fear Russia retaliates with the nuclear option. Risk-off sentiment initially gripped financial markets before subsiding on the likelihood peace talks could unfold early next year. President-elect Donald Trump promised to end the Ukraine-Russia war “in 24 hours” once in office.

Kansas City Fed President Schmid (2025 voter) repeated his comments from last week that “while now is the time to begin dialing back the restrictiveness of monetary policy, it remains to be seen how much further interest rates will decline or where they might eventually settle.” Fed funds futures imply a 60% probability of a 25bps rate at the upcoming December 18 meeting and a total of 75bps of easing over the next 12 months.

Overall, the bias is for a stronger USD because there is greater room for an upward reassessment in US interest rate expectations relative to other major economies. The US economy is still tracking above long-run annual trend growth of 1.8%. The Atlanta Fed GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in Q4 is 2.6%, up from 2.5% on November 15.

There are no policy-relevant U.S. economic data releases today. Fed speakers include: Fed Vice Chair for Supervision Barr (3:00pm London), Fed Governor Cook (4:00pm London), Fed Governor Bowman (5:15pm London), and Boston Fed President Collins (2025 voter) (9:00pm London).

GBP rallied against all major currencies on higher UK inflation pressures. In October, headline CPI rose to 2.3% y/y (consensus and BOE forecast: 2.2%) vs. 1.7% in September driven by electricity and gas prices. Core CPI (excluding energy, food, alcohol and tobacco) and services CPI increased 0.1pts to 3.3% y/y (consensus: 3.1%) and 5.0% y/y (consensus: 4.9%, BOE forecast: 5.0%), respectively.

Stubbornly high UK services price inflation reinforces the case the BOE pauses easing at its December 19 meeting. Markets are pricing-in less than 10% odds of a 25bps BOE rate cut next month. The ECB is more dovish, suggesting EUR/GBP can edge lower. BOE Deputy Governor Ramsden speaks on monetary policy later today (4:00pm London).

EUR/USD is holding under 1.0600. The ECB Financial Stability Review (9:00am London) and Q3 Eurozone negotiated wages indicator (10:00am London) are the domestic highlights. Negotiated wage growth slowed to 3.55% in Q2 from 4.74% in Q1. The ECB’s forward-looking wage tracker points to further easing in wage pressures, leaving plenty of room for the ECB to keep easing.

USD/JPY is firmer above 155.00 following yesterday’s kneejerk geopolitical tension related drop to lows near 153.30. Japan’s cumulative merchandise trade deficit narrowed to -¥5.95tn (or -1% of GDP) vs. -¥6.07tn in September. The cumulative trade surplus with the US narrowed slightly in October but remains historically high at over ¥8.8tn (1.4% of GDP), placing Japan’s economy at a modest disadvantage in case trade tensions with the US rise.

USD/CAD is holding on to yesterday’s loss triggered by hotter than expected inflation in Canada. In October, headline inflation rose to 2.0% y/y (consensus: 1.9%) vs. 1.6% in September on slower decline in gasoline prices. Core inflation (average of trim and median CPI) increased to 2.55% y/y (consensus: 2.4%) vs. 2.35% in September, tracking above the Bank of Canada’s Q4 projection of 2.3%.

Odds of a 50bps Bank of Canada (BOC) December rate cut eased briefly to 30% vs. 40% before the CPI data. We still expect the BOC to deliver follow-up jumbo rate cut next month because inflation is close to 2%, and inflationary pressures are no longer broad-based. Additionally, monetary policy remains too tight, heightening the downside risk to the economy. At 3.75%, the BOC policy rate remains above the bank’s nominal neutral interest rate estimate of 2.25% to 3.25%.

NZD/USD pared back some of yesterday’s gains. Whole milk powder (WMP) prices – New Zealand’s biggest commodity export – rose to $3826/mt, the highest level since July 2022. Higher WMP prices will lead to a further improvement in New Zealand’s terms of trade which is a tailwind to growth.

Nevertheless, NZD/USD should continue to trade on the defensive because the RBNZ has plenty of room to crank-up easing. Monetary policy is too tight, raising the risk of a deeper economic downturn. At 4.75%, the RBNZ policy rate is still well above the RBNZ estimate for the nominal neutral rate range of 2% to 4%. The market has fully priced-in a 50bps policy rate cut at the November 27 meeting and implies a 17% probability of a 75bps move.

USD/CNH is holding near recent highs. As was widely expected, Chinese commercial banks left the 1- and 5-year Loan Prime Rates (LPR) unchanged at 3.10% and 3.60%, respectively. The People’s Bank of China will set its 1-year MLF rate this week and is expected to keep it steady at 2.0%. We remain skeptical that the stimulus measures announced so far will have much lasting impact on the economy.

EUR/HUF is trading near the middle of this month’s 404.00-412.00 range. As was widely expected, National Bank of Hungary (NBH) kept rates steady at 6.50% yesterday. Only one MPC member recommended a rate cut suggesting the bar for NBH to resume easing is high which offers HUF support vs. other EMFX. Indeed, NBH noted again that “the base rate may remain at the current level for an extended period,” and emphasized that a “stability-oriented approach to monetary policy is of key importance.” The swaps market continues to fully price-in 50bps of cuts over the next 12 months.

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