The global economy at a tipping point. Since the beginning of 2022, there has been one overarching theme which has driven monetary policy decisions from central banks globally. This was the severe destabilization of price levels caused by supply side pressures from Covid lockdowns and the war in Ukraine. In the past few months, we have seen the effects of sharp rises in interest rates bring down inflation and the conversation switch to whether or not rate reductions can be expected. We have seen softening in language from ECB and BoE members around potential rate cuts. No surprises here considering the UK and the Eurozone have very weak GDP growth forecasts. The risks of overtightening are now very real for central banks; we have seen Jay Powell of the FED reference this in a number of speeches recently. The primary role of a central bank is to ensure price stability, but employment and growth are part of their purview also. Historically central banks have loosened monetary policy too soon in times of high inflation, leading to the inflation spirals of the 70s and 80s. This time around they acted quickly and tightened at record pace, in order to avoid this, as a wage-price spiral is considered a much worse alternative to any potential recession. Now central banks have the tough task of knowing when to cut without under- or over- tightening. Loosening too soon would lead to the same problems as the past, while over-tightening could well lead to another recession or even a financial crisis. It’s certainly a tight rope to walk. Who would want to be a central bank governor in 2023/24?
- The past week saw volatility in the US Dollar Index but the greenback ended the week trading 0.7% higher. There were relatively few data releases last week; the major market movers were a surprise uptick in continuing jobless claims data on Thursday, which saw the dollar weaken. This backed up the weaker than expected payrolls report the Friday prior, suggesting further slackening in the labour market.
- The Dollar had gained on Wednesday, however, following FED Chair Powell’s speech. Here he stated the FED will not hesitate to raise interest rates again if necessary and the central bank would not be led by a few good months of easing price pressures. He highlighted the economy’s remarkable resilience in face of rising rates, with a still-tight labour market and strong growth, but acknowledged economic activity had begun to slow down.
- Swaps markets have begun to price-in cuts in 2024 following acknowledgements from ECB and BoE members that this may be appropriate next year. The FED, however, has not yet indicated this could be on their roadmap. If we see such acknowledgements from FED members in this quarter, we could well see a reversal of the unilateral USD strength of the last four months.
- Looking to the week ahead, we have a key inflation print on Tuesday where markets have forecast a drop in headline inflation to 3.3% year on year, but core inflation to remain steady at 4.1%. This, combined with releases from the UK and Eurozone, will likely be the main driver of USD strength or weakness in the coming week and cause volatility in FED futures.
- In China we saw the exchange rate hold relatively flat against the dollar, just a touch below 7.3. Data released last week from the world’s second largest economy did little to alleviate concerns around economic stability. Both consumer and producer prices are now in deflationary territory, driven by weak domestic demand and economic activity. This was further backed up by Tuesday’s trade data, which showed a sharp 6.4% drop in exports for October as buyers are moving their purchases to other nations such as India, Pakistan, Brazil, and Mexico. This week there are further data releases for industrial production, retail sales and housing prices. This will give a clearer picture of the domestic landscape and markets will have a keen eye on any further softening in the struggling real estate sector.
- The emergence of deflation in China will be of particular concern to the economic authorities there. Deflation is an unusual condition for a modern economy and a notable indicator of pathology. Like inflation, it can become entrenched via the expectations of economic actors and comparative amplification of all debt burdens. It discourages new economic activity and can be resistant to monetary policy remedies if firms and individuals prefer to hoard new spending power injected into the system rather than spend it – the so called ‘liquidity trap’. If this scenario looks set to materialize, there is a good chance of more aggressive stimulus to prevent deflationary expectations becoming deeply entrenched as happened in Japan in the 1990s and early 2000s. This, in turn, would shift the Yuan. Keep a close eye on China’s price data in the coming months.
- The weakness of the Chinese economy has had a paradoxical effect in terms of international adoption of its currency. Because interest rates are so much lower in the Yuan than in the Dollar, international players have shifted some of their borrowing to the former, and the Chinese central bank has sought to capitalize on this by opening up currency swap lines with dozens of emerging market central banks. This, in turn, is causing certain countries to make greater use of the ‘redback’ in trade.
- The Yen depreciated a further 1.5% against the dollar last week, despite very little in terms of market-moving data being released. JPY weakness is largely being led by a lack of clarity from the BoJ around its plans for future monetary policy and timescales for changes. Plans for fiscal stimulus have been moved to mid-2024, which suggests any changes to monetary policy are not on the table right now. Last week the BoJ changed its 1% limit on 10-year government bond yields, but the only communication since has been from its head, Ueda, in which he announced the unwinding of further ultra-loose policies will be extremely difficult and take time. This has been taken to suggest division within policy-making circles. The big worry is that inflationary pressures are imported and not domestically-driven. With price pressures easing worldwide, a sudden shift to tighter monetary policy could have a deeply negative impact on growth expectations. This could then lead to the need for large scale government stimulus – all from a country with the worst estimated debt to GDP ratio globally at a reported 262%. A rumored central bank FX intervention seems to be the only path for JPY appreciation in the near term.
- A disappointing week for Australian Dollar would be an understatement; it finished the week trading 2.4% lower than it started against USD. The RBA hiked rates for the first time in five meetings to 4.35%. Markets have now priced-in no further hikes from the central bank in the wake of a deteriorating domestic picture. The housing market is in deep decline with new building permits down over 20% year on year. Australia’s major trading partner, China, is showing little in terms of economic recovery to help improve Australia’s own domestic picture. Employment and earnings figures, being released this week, will give a good picture of the fundamental strength of the Australian economy.
- INR remained steady slightly weaker than 83 vs USD last week as the Indian economy appears to be in good health. Manufacturing and industrial production both missed expectations but are still showing strong expansion. Other than that, no major economic news from India last week.
- PKR depreciated by 1% against USD last week, ending the week trading at 286.8. Over the past eleven weeks, forex reserves have decreased by just under $300 million due to lower exports and higher oil prices dampening economic activity. In terms of data releases, there was nothing significant out of Pakistan last week.
- The Nigerian Naira is still enduring a volatile period, with a 1.5% depreciation on official markets against USD last week. There were, in addition, signs of further dollar shortages following a CBN FX intervention on the 1st of November. On the unofficial market there was a 10% depreciation as flows moved back from official channels. The Central Bank of Naira has vowed to punish currency hoarders as it blames powerful individuals and corporates for continued depreciation of the Naira. Whether this can be implemented is yet to be seen.
- Kenyan Shilling moved to fresh lows against the dollar last week as the country continues to battle against worsening dollar shortages on the ground. This is being further exacerbated by rising oil prices, making it more difficult for Kenya to meet its forex demands. Kenya's public debt soared to KSh10.58 trillion in September as questions arise about the nation's economic stability in the wake of severe liquidity pressures.
- The Tanzanian Shilling consolidated against USD last week back at a level of 2,500. End of the month forex demands from oil imports were matched off by exports in manufacturing, tourism, and agriculture. Other than that, no major news out on Tanzania last week.
- South African Rand gave up nearly all its gains of the previous week, ending up 2.5% down against USD. A disappointing string of manufacturing and mining data was compounded by a decrease in forex reserves. ZAR holders will be hoping for positive employment and retail sales data in the week ahead.
- GBP depreciated by 1.2% against the dollar last week, giving up most of the gains made the week prior. From a data point of view, we saw a slight rebound in house prices but Q3 growth came in flat at 0% with misses in manufacturing and industrial production. The BoE is between a rock and a hard place with high inflation alongside low growth expectations. FED Chair Powell’s hawkish speech on Thursday put downwards pressure on sterling along with the less than flattering data releases. In the week ahead we have key inflation releases from both the UK and the US. UK inflation is expected to dip to 4.8% with the core reading forecast to drop to 5.8% on an annualized basis. Any surprises to the upward or downward side will likely cause large movements in USD/GBP this week as future markets are repriced.
- The Euro is back trading below 1.07 against USD, giving up some of the gains following a strong start to November. There was very little in terms of market-moving data from the Eurozone except a weak retail sales print for September, showing a 0.3% monthly decline. The negative move was driven by dollar strength in large part. The key in the coming week will be the inflation print on Friday. Markets have currently priced-in no further hikes from the ECB; an upside surprise could lead to strengthening for the common currency and a drop would likely see further declines.
- Moody's on Friday lowered its outlook on the U.S. credit rating, increasing the odds of a downgrade of the only remaining top rating of the country by the third major assessor. The move comes months after a similar downgrade by Fitch and cites large fiscal deficits and a decline in debt affordability.
- Russia's depleted labour force is causing acute labour shortages and threatening economic growth, Central Bank Governor Elvira Nabiullina said on Thursday, as Moscow pumps fiscal and physical resources into the military. The war in Ukraine is pulling funds away from other sectors of the economy, while worker shortages and record low unemployment add to inflationary pressure through higher wages that has seen interest rates surge to 15%.
- The Bank of England has instructed major banks under its supervision to complete a detailed stress test involving a scenario of a sudden surge in yields on the government bonds of the US, UK, and other major issuers. This tells us that a key watcher of the world economy is worried about some pretty concerning scenarios. They may have in mind a geopolitical shock such as China invading Taiwan, although that could arguably cause US treasury yields to move in the other direction as investors flee to safety. They might also be thinking of Trump winning the election in 2024 and the start of 2025 seeing enactment, or attempts to enact, some rather extreme policies, including high and escalating tariff levels across all goods that would trigger a big dislocation in the world economy.
PERFORMANCES AGAINST US DOLLAR
- Japan PPI
- US Consumer Inflation Expectations
- UK Unemployment Rate
- UK Average Earnings
- EU Employment Change
- US Inflation Rate
- Japan Q3 GDP Growth Rate
- Australia Wage Price Index
- China Industrial Production
- China Retail Sales
- UK Inflation Rate
- EU Industrial Production
- US PPI
- US Retail Sales
- Japan Balance of Trade
- Australia Unemployment Rate
- China House Price Index
- Canada Housing Starts
- US Industrial Production
- US Manufacturing Production
- UK Retail Sales
- EU Inflation Rate
- Canada PPI
- US Building Permits
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