December Rate Hike Probabilities:
USD 80.2% + (Getting ever clearer)
EUR 2.5% − (Think December 2019)
GBP 81.7% + (Done deal, probably in November)
CAD 64.0% − (Not as confident as before)
A nation that sits in between
Both Asia and Europe has seen
It’s currency tumble
As diplomats grumble
‘Bout visas that once were routine
Ordinarily, the Turkish lira is not a highlight of the FX markets, as the nation’s economy is neither too large (19th largest globally) nor international, thus trade flows remain muted overall. But I would be remiss if I did not lead with the TRY this morning as it has fallen more than 2% (and was previously lower by as much as 6.6%) after a spat between the US and Turkey intensified today. The issue revolves around the arrest of a Turkish employee at the US consulate in Istanbul, and the rights of consulate employees. So while there is no direct financial impact, the market is clearly concerned that if tensions continue to escalate, there could be economic issues down the road. Is this a harbinger for other EMG currencies to see pressure? While anything is possible, it doesn’t seem to be the case as this is very specific to Turkey and the US. However, contagion is a funny thing and one cannot completely rule out a wider impact, however unlikely.
But on this Columbus Day holiday in the US, away from TRY, there is very little going on in the FX markets. The pound has been the biggest mover in the G10 (in fact the only currency to have moved more than a few pips) as it has rallied 0.65%. This rally, breaking a multi-day slide, is on the back of revised Unit Labor Cost data (+2.4% in Q2 up from +1.6% previously reported), which has helped the cause of the BOE hawks. As can be seen above, the probability of a rate hike in the UK continues to grow, and while I have been using December in deference to the Fed, the BOE is likely to go at its November meeting when it publishes new inflation forecasts as well. However, while I understand the positive sentiment today, the reality continues to be that the pound has far more reasons to fall than rise. The politics of Brexit continue to rage in the UK and there continues to be limited progress with negotiations. And no matter the long-term outcome, a hard Brexit, which seems now to be the most likely scenario, will be a decided short term negative for the pound. Rallies are to be sold in the pound.
But with little else on the docket today, we can review Friday’s Payroll data. The headline payroll numbers were shockingly worse than expected (-33K, exp +80K) with similar misses for Private and Manufacturing data. But the Unemployment Rate tumbled to 4.2% and Average Hourly Earnings jumped to 0.5% (2.9% Y/Y) amid growth in the Participation rate. Given the uncertainty surrounding the impact of the two major hurricanes that made landfall in September, it is not surprising that economic models did not forecast the data well. However, the balance of good and bad data was enough to inspire investors, and more importantly, should certainly be enough to keep the FOMC on target for its rate hike in December. Even the Fed Funds futures market, which has been extremely skeptical of the Fed to date, has priced in a greater than 80% probability of Fed action come December. Looking ahead, I continue to see the dollar improving as this market grudgingly accepts the Fed rhetoric and starts pricing in more rate hikes in 2018.
As to the week ahead, it is inflation week here in the US, with both PPI and CPI to be released, following Wednesday’s release of the Minutes of the September FOMC meeting.
Tuesday NFIB Small Biz Optimism 105.0
Wednesday JOLTS Jobs Report 6160K
Thursday Initial Claims 252K
-ex food & energy 0.2%
Friday CPI 0.6%
-ex food & energy 0.2%
Michigan Sentiment 95.0
Business Inventories 0.6%
So between now and Friday, we will need to find other catalysts to drive markets (my sense is the Minutes will not teach us anything new). Fortunately, Fed speakers have the chance to fill the void. There are six speakers during the week (seemingly more doves than hawks) and with the annual IMF meetings in Washington DC, certainly, headline risk is a real possibility, although it would be shocking if anyone other than Kashkari disagrees with the plans to raise rates in December. Finally, Chair Yellen speaks next Sunday morning at a G30 event, so we will have something to look forward to next Monday morning as well.
All told, nothing has changed that I can see. The Fed is still on track to continue to tighten policy and while both the BOE and the BOC are moving in that direction, neither is likely to be as aggressive as the Fed. I believe it is a mistake to assume the ECB is going to get on board that quickly and the BOJ may never get on board. I still like the dollar overall.