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Growing conviction in US “soft landing” supports risk appetite

Markets are trading with a mildly supportive tone this morning after yesterday’s third-quarter growth data showed US inflation pressures continuing to fade even as consumer spending remained robust – conditions closely resembling those the Federal Reserve has been working to engineer. After dropping almost ten basis points, ten-year Treasury yields are holding near 4.86 percent, and most major currencies are strengthening against an incrementally weaker dollar. Equity futures are gaining ahead of the North American open on solid earnings guidance from Amazon and Intel, and oil prices are higher after the US launched “precision self-defense” strikes against two Iran-linked facilities in eastern Syria, modestly raising perceived escalation risks.

The euro remains soft after the European Central Bank held policy settings steady yesterday, surprising no one in announcing a pause in its tightening cycle after hiking rates at ten consecutive meetings. Underlying inflation pressures have subsided and the common currency area looks increasingly likely to tumble into recession by the first quarter of 2023, justifying a more cautious approach for now. Recovering from a prolonged period of delusion, markets now expect Europe to begin cutting rates before the Federal Reserve, and rate differentials have widened against the euro across the front end of the curve.

Core consumer price growth unexpectedly accelerated in Tokyo earlier this month, with a measure that excludes fresh food but includes fuel costs rising 2.7 percent in October from a year earlier, topping forecasts for a 2.5 percent gain. The yen is finding support near the 150 mark against the dollar as expectations for a tweak in yield curve control policies at next week’s Bank of Japan meeting continue to rise.

Beyond an initial knee-jerk reaction, we’re still not convinced a move would be all that consequential. Japan’s comparatively-weak growth and inflation prospects should keep an unconstrained yield curve capped near current levels. Large institutional asset managers might repatriate some of their holdings, but the more attractive returns on offer in global markets could keep outbound investment levels high. And rate differentials should remain firmly tilted against the yen, keeping carry flows alive for some time to come.

Still ahead: An update in the Federal Reserve’s preferred inflation indicator could move markets around 8:30, and the University of Michigan’s consumer sentiment index will provide grist for news headlines at 10:00, even if the heavily-partisan data doesn’t deliver meaningful insight into likely spending patterns. We note that trading activity ahead of the last three weekends has exhibited risk-off characteristics, with the dollar and Swiss franc gaining each Friday as traders sought protection against geopolitical risks in the Middle East, only to see those gains unwind after the Asian open on Sunday night. A similar pattern could play out this weekend, although early indications would suggest that it should be smaller in scale.

Still Ahead


The Federal Reserve’s preferred inflation indicator is thought to have accelerated slightly in August, with consumer outlays rising at a strong clip on higher gasoline prices and continued wage growth. Consensus forecasts – and Jerome Powell’s comments last week – suggest the core personal consumption expenditures index rose 0.3 percent month-over-month, speeding up from 0.1 percent in August, and climbing 3.7 percent year-over-year. Based on estimates derived from earlier data releases – including retail sales and the non-farm payrolls report – personal spending likely increased at least 0.5 percent, and incomes might have risen 0.4 percent. (08:30 EDT)

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