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Rate cut bets solidify, pushing global markets higher

Markets are high on rate-cut hopium again this morning, with risk-sensitive assets extending a rally that began yesterday when Federal Reserve Governor Waller set the stage for a policy pivot in early 2024. In a speech and interview, the erstwhile hawk said he was “increasingly confident that policy is currently well-positioned to slow the economy and get inflation back to 2 percent,”—indicating that the central bank’s rate-setting committee was unlikely to raise rates further—before suggesting that a “hard landing” wouldn’t necessarily be needed to prompt rate cuts. If the decline in inflation continues “for several more months… three months, four months, five months… we could start lowering the policy rate just because inflation is lower,” he said. “It has nothing to do with trying to save the economy. It is consistent with every policy rule… There is no reason to say we would keep it really high”.

Swaps are now priced for over 100 basis points of loosening in 2024, with odds on the first cut happening in May—just four meetings away—holding above 50 percent, despite hawkish signals from other policymakers. Also speaking yesterday, Governor Bowman said “My baseline economic outlook continues to expect that we will need to increase the federal funds rate further to keep policy sufficiently restrictive to bring inflation down to our two-percent target in a timely way”.

Both major global oil benchmarks are holding yesterday’s gains as traders brace for wider supply cuts at tomorrow’s OPEC+ meeting. With Saudi Arabia reportedly facing resistance as it pushes other cartel members to agree to an additional 1-million barrel-per-day output reduction, considerable uncertainty remains around near-term market direction. Prices have fallen by more than 20 percent from their late-summer peak, and the longer-term demand outlook remains dire.

The Canadian dollar is trading near a nine-week high, with an improvement in global risk appetite overshadowing the imminent release of data that should show the economy continuing to slow. Tomorrow’s September gross domestic product report and Friday’s job numbers are both expected to exhibit signs of deepening weakness, putting the Bank of Canada on course to deliver rate cuts at a pace similar to the Federal Reserve’s in 2024. We think the more rate-sensitive Canadian economy will ultimately require an even more aggressive move from policymakers – but we don’t expect this to become market consensus until late in the first quarter. We’re sticking to our tactically constructive view on the loonie, with a modest gain expected into year end, paired with a more bearish perspective for early 2024, with fundamentals arguing for renewed weakness by the end of Q1.

The Japanese yen is stable after inching higher on a US-driven narrowing in rate differentials. In comments last night, Bank of Japan Board Member Seiji Adachi joined Governor Kazuo Ueda in pushing back against easing expectations, saying “There seems to be emerging views that the bank is laying the groundwork for an exit, after October’s move to add flexibility to yield curve control. But we need to continue with easing patiently, and we’re not at a phase to discuss an exit strategy, given the current economy and inflation”. In fairly explicit terms, he suggested that policy changes were unlikely to come until after the “Shuntō” annual wage negotiations between unions and employers conclude ahead of the new fiscal year in April 2024.

Rather remarkably, the euro is back under the 1.10 mark after breaching resistance around the big handle during yesterday’s session. Cross-Atlantic rate differentials are moving back against the common currency as traders position ahead of tomorrow’s data, which is expected to show further easing in bloc-wide inflation levels, clearing the way for rate cuts from already nominally-lower levels in 2024. We still think that further softness in US economic surprise indices relative to their European equivalents will help push the pair back through 1.10 on a sustained basis, but recent price action certainly suggests caution is warranted.

Today’s data calendar is light, with a second print of US third-quarter gross domestic product and the Fed’s Beige Book survey offering economists—not market participants—something to chew on. But reversal risks could emerge around tomorrow’s personal consumption expenditures data and Friday’s appearance from Jerome Powell. The Fed’s preferred inflation measure should show signs of continued easing, yet spending numbers might remain stubbornly elevated, and Powell could seize the opportunity to push back against a premature loosening in financial conditions.

Lastly, in honour of Charlie Munger’s passing yesterday – someone who brought intelligence and a rare sense of humour to the financial profession – we’ll leave you with one of his best pieces of advice, as applicable to foreign exchange trading as it is to investing: “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent”.

THURSDAY

Euro area consumer price growth likely decelerated further in November, helping mute any remaining hawks on the European Central Bank’s Governing Council. Headline inflation is seen easing to 2.7 percent year-over-year, down from 2.9 in the prior month, while the core measure might have slipped closer to 3.8 percent from 4.2 previously. This shouldn’t support a dramatic change in the central bank’s rhetorical stance – officials will likely maintain an aggressive inflation-fighting posture for many months yet – but with markets overwhelmingly convinced policy has been overtightened, might support further narrowing in expected cross-Atlantic rate trajectories for next year. (05:00 EDT)

Personal income and consumption numbers should show US household demand beginning to ebb in October, giving the Fed room to maintain rates at current levels through the early part of next year. With labour markets showing clear signs of exhaustion, wage gains should slow, with investment returns doing the heavy lifting in keeping income gains – narrowly – on the positive side of the ledger. Spending levels are widely expected to slow, dropping to 0.2 percent month-over-month, down from 0.7 percent in September – but an upside surprise is certainly possible, given consumers’ recent propensity to spend more than they earn. And the central bank’s preferred inflation indicator – the core personal consumption expenditures index – is seen slowing further, falling to 0.2 percent month-over-month and 3.5 percent year-over-year. (08:30 EDT)

The Canadian economy likely dipped into a technical recession in the third quarter, with updated numbers expected to confirm Statistics Canada’s preliminary estimates. Data out in October showed activity contracting an annualized -0.1 percent in the three months ended September, following a -0.2 percent decline in the prior quarter. This, in and of itself, is unlikely to impact the Canadian dollar – traders already expect the central bank to stay on hold before beginning to cut rates in mid-2024 – but the preliminary estimate for October could easily move markets, helping determine whether the easing timetable should be moved up. (08:30 EDT)

FRIDAY

We are looking for another decline in job creation in Canada’s November Labour Force Survey, adding to October’s print in offsetting strong gains through August and September. Even if the headline is positive, the mix between full- and part-time jobs will be critical in discerning the underlying trend, with seasonal retail hiring ramping up even as a profound slowdown in the services sector drags down growth. The unemployment rate is likely to rise as labour markets fail to absorb higher immigration levels. (08:30 EDT)

The Institute for Supply Management’s manufacturing gauge likely stayed in contractionary territory in November, but a modest pickup in demand should mean that the pace of deterioration has slowed somewhat. Markets will review respondent anecdotes closely however, with more talk of “recession” helping moderate any potential revival in animal spirits. (10:00 EDT)

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Higher for (even) longer