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Too Soon for Fed to Pivot

Market movers today

In Germany, the IFO survey of business expectations is expected to show further declines mirroring yesterday’s weak PMI report for the manufacturing sector. This supports our view that the German economy is likely to fall into recession in Q3, which together with high inflation makes it difficult for both the ECB and the government in Berlin to deal with.

The US Conference Board survey of consumer confidence should show a small decline amid higher interest rates and declining asset prices. Yet, the measure remains much higher than the Michigan survey as it takes the strong labour market into account.

In the US, house price developments in October will also get more attention than usual given concerns that the sharp spike in mortgage rates is hitting housing demand and prices, which could initiate a broader downturn in the economy.

The 60 second overview

Markets: While many important macro stories are unfolding right now the most important one is in our view market speculations that the Fed could be closer to a policy pivot in a more dovish direction. Notably, despite the recent move lower in natural gas prices longer-term market based inflation expectations continue to creep higher. In our view, that highlights that it is still too early for central banks including the Fed to turn into a more accommodative mode since this risks jeopardizing the fight against higher inflation. That said, since Friday’s Wall Street Journal article lifted the pivot-speculations we have seen US rates come lower and US equity prices rally.

Of other important stories Chinese equities have rebounded this morning following some otherwise very sour sessions with markets digesting President Xi Jinping’s consolidation of power over the weekend. The CNY has this morning hit new lows and it seems Chinese policy makers increasingly accept and/or welcome currency weakness in the current environment.

In Japan, FX intervention risks remain but we highlight that Japanese policy makers face a decision between sticking to yield-curve control and/or credibly fighting JPY-strength.

UK: Yesterday, former chancellor Rishi Sunak was elected new prime minister of the UK, set to formally replace Liz Truss later today. This was broadly welcomed by markets given Sunak’s firmer stance on fiscal discipline. At present, we see low likelihood of the medium-teem fiscal plan being further delayed and high likelihood that Jeremy Hunt will be staying on as chancellor in a bid to reassure markets.

PMIs: Yesterday’s bunch of preliminary PMIs were generally disappointing reading both in terms of headlines but also when it comes to the details. In Europe the manufacturing PMIs hit new lows at 46.6 highlighting how the downturn seems to have gathered pace heading into Q4 with increasing strains on competitiveness from rising energy, wage and borrowing costs. Although supply bottlenecks showed further signs of easing, inflationary pressures remained stubbornly high and the weaker demand environment does not yet seem to have weakened firms’ pricing power noticeably.

The US PMIs also fell short of expectations with the flash manufacturing estimate falling below the 50 threshold indicating falling activity levels ahead. Notably, the details also showed that the drop was driven by new orders. Importantly, the employment indices for both manufacturing and services fell below 50 indicating a drop in employment ahead – albeit other indicators paint a more positive outlook for the labour market. Meanwhile, output prices remained elevated highlighting the difficult balancing act that central banks face in stagflationary environments.

Equities: Equities started the week higher, lifted by yields plunging in the UK on the back of Rishi Sunak becoming the new PM. Interesting to see equities higher on a day with macro being exceptionally weak. A look at the underling sector/industry story suggest this is a low conviction rally. In the US defensives outperformed with the top five performing industries being defensives. Equity relief is coming as yields, inflation and CB’s scare is fading but recession risk is increasing and hence investors buying the least earnings sensitive stocks. In US Dow +1.3%, S&P 500 +1.2%, Nasdaq +0.9%, Russell 2000 +0.4%. Asia is higher this morning with a little comeback to China after yesterday’s massive sell-off. European and US futures marginally higher.

FI: European rates generally declined in yesterday’s session with the longer end falling more than the short end driving a generally flattening of curves. UK rates moved lower on Sunak becoming the new PM but also Italian government bonds had a good session with spreads narrowing to Germany.

FX: Implied volatilities in major G10 crosses, in particular USD/JPY and GBP/USD, came lower on Monday after last week’s yen interventions and with the new UK PM in place. USD/JPY post-intervention price action similar to when BoJ intervened last time. Meanwhile, there was no follow-through to the no-Boris rally in sterling. A green day in equities eventually pulled Scandies lower with EUR/SEK around 11.00 and EUR/NOK around 10.37. EUR/USD slightly bid, yet below 0.99.

Credit: Credit markets were in a cheery mood on Monday, following along the relief rally in major western equity indicies. Itrax main tightened 3.6bp to close at 121.5bp. Itrax Xover tightened 15.2bp to close at 587bp. Despite the good tone in secondary markets, primary market activity was relatively muted.

Danske Bank
Danske Bankhttp://www.danskebank.com/danskeresearch
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