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Summary

United States: The Best of Summer Gone, and the New Fall Uncertain

• The Consumer Price Index picked up 0.6% in August—the largest monthly gain since June 2022. The outturn was broadly expected amid the surge in gasoline prices last month. Short-term and long-term consumer inflation expectations declined, suggesting consumers are more convinced that inflation is cooling.
• Next week: Housing Starts (Tue), Existing Home Sales (Thu), Leading Economic Index (Thu)

International: The ECB's Dovish Hike

• Leading into the European Central Bank's (ECB) September assessment of monetary policy, we felt policymakers would opt to end their respective tightening cycle. Needless to say, ECB policymakers delivered another 25 bps of tightening; however, the forward guidance associated with the decision became the larger focus of the meeting.
• Next week: Brazilian Central Bank (Wed), Bank of England (Thu), Bank of Japan (Fri)

Interest Rate Watch: FOMC to Stand Pat, but Keep Door Open to Possibility of Further Hikes

• The FOMC is widely expected to keep the fed funds target rate unchanged at 5.25-5.50% at its upcoming meeting as inflation has more clearly started to slow. However, with price growth still running well-above target, we expect the hold to be delivered with the message that further policy tightening is possible if incoming data warrants it.

Credit Market Insights: How Tight Are Financial Conditions?

• Some recent data point to a tightening and costlier credit market, but how tight are financial conditions broadly? Timely evidence from the Federal Reserve Bank of Chicago suggests national financial conditions are still looser than average and have been easing in recent weeks.

Topic of the Week: Median Household Income Falls in 2022

• The U.S. Census Bureau released its annual Income & Poverty Report this week, which showed that U.S. incomes fell for the third straight year in 2022. Real median household income before taxes fell to $74,580 in 2022, down 2.3% from the 2021 estimate of $76,330.

Full report here.

U.S. Highlights

• The third quarter is shaping up to be the strongest of the year for the U.S. economy, with GDP tracking 3.7% q/q (annualized).
• The August reading of CPI showed inflationary pressures accelerated last month, though the trend remains favorable, with the three-month annualized change on core inflation slipping to 2.4%.
• A 1-2-3 punch of risks lies on the horizon for the U.S. economy. The end of the student debt moratorium, a potential government shutdown, and the UAW strike could all leave a mark on Q4 growth.

Canadian Highlights

• We can’t fault Canadian investors for peeking south of the border for signs on what the Bank of Canada (BoC) is going to do next. The stronger than expected U.S. Consumer Price Index (CPI) print may provide a good guide for Canada’s CPI release next week.
• The BoC has spoken about the stickiness of Canadian inflation as a rationale for its higher for longer interest rate strategy. The expectation for another increase in CPI next week has government yields and mortgage rates stabilizing at higher levels.
• While inflation has been slow to respond to the BoC’s hikes, there has been a clear deceleration in Canadian economic momentum over the last few months. Look no further than the August real estate data, which showed another drop in sales activity and prices.

U.S. – Flying High in Q3, But Headwinds on the Horizon

There were a lot of new data reads on the U.S. economy this week, but on balance it is looking like the third quarter is shaping up to be the strongest of the year. Real GDP growth is on track for a nearly 4% q/q (annualized) pace! That performance is driven by defiant consumer spending, which is also close to 4% even though August retail sales weren’t much to write home about. The tradeoff, however, is that persistently higher demand undermines the Fed’s efforts to cool inflation. That was evident in the August CPI data, where both headline and core inflation accelerated relative to July.

Over half of the gain in headline inflation was due to higher gasoline prices, which rose sharply alongside the recent uptick in oil prices. Meanwhile, the 0.3% m/m gain in core inflation came in a tick above expectations and bucked the trend from the ‘soft’ 0.2% gains seen in both June and July (Chart 1). However, putting these numbers in context, the monthly gain was still the third smallest in nearly two-years. Moreover, the trend on inflation remains favorable, with the three-month annualized pace cooling to 2.4% – the slowest pace of growth since March 2021.

Next week’s interest rate announcement hangs in the balance, where it is widely expected that the Federal Reserve will keep the policy rate unchanged. However, the devil will be in the details. The FOMC will also release revised economic projections, where at a minimum, they’re likely to lift the near-term growth forecast and lower the unemployment rate projection to account for the more persistent strength since the June update. The big question will be if policymakers see the near-term resilience as a source of more persistent inflationary pressures, and whether that alters the expected future path of the fed funds rate. While it is very unlikely that the FOMC would lift its terminal rate projection of 5.75% for 2023, a shallower rate cut trajectory could be signaled, reinforcing the need for rates to remain higher for longer.

The Fed needs to thread a very small needle in its communication next week. While policymakers will need to show a continued commitment to fight inflation, coming off too hawkish runs the risk of leading to an over tightening in financial conditions. This is particularly crucial now, as there is a trifecta of headwinds to fourth quarter growth on the horizon: the end of the student debt moratorium, a potential government shutdown, and the United Auto Workers (UAW) strike. The UAW strike, which began Thursday evening, comes just as auto production had normalized to pre-pandemic levels (Chart 2). As it currently stands, the UAW has announced work stoppages at three facilities, accounting for about 7.5% of overall U.S. production. Assuming no other stoppages, this alone would shave about 0.025 percentage points (pp) for each week the strike lasts. The hit from a government shutdown is a multiple of that, while the impact of the end of the student debt moratorium could have a cumulative Q4 hit of 0.3pp. So, while growth is flying high in the third quarter, there’s the potential it ends 2023 with a thud!

Canada – Waiting in Inflation Limbo

We can't fault Canadian investors for peeking south of the border for an indication of what the Bank of Canada (BoC) is going to do next. The stronger than expected U.S. CPI print may provide a good guide for Canada's CPI release next week. The expected rebound in Canadian inflation has raised bets of another BoC hike by year-end. Canadian yields have subsequently kept pace with their U.S. equivalents this week, putting a floor under the loonie at 73 U.S. cents (Chart 1).

Our expectation is that Canadian consumer price inflation will show a hefty increase – hitting 3.8% year-on-year (y/y), from 3.3% y/y in July and 2.8% y/y in June. The 5% month-on-month pop in the price of gasoline will once again be the culprit for rising CPI in August. But given its volatility, the BoC would be right to look straight past that headline print and focus on the movement of core inflation. Unfortunately, we aren't expecting much progress here. There is no longer any downdraft coming from base effects and the three-month average of monthly price movements in the BoC's two core measures appears stuck at the mid-3% level (Chart 2). No wonder the BoC has been reinforcing that investors shouldn't rule out more rate hikes.

Part of the rationale for the BoC's hawkishness has been the resiliency of the Canadian consumer. Given an improved financial position, consumers have been able to withstand the impact of higher rates. Adding to this narrative was the release of Canadian household wealth data, which revealed an overall improvement in net worth. Canadian's wealth grew by a whopping $256 billion in 2023 Q2. This only adds to the financial cushion of Canadians, who already have approximately $140 billion in excess savings that have yet to be spent. This could pose a problem for the BoC if consumers decide to spend their newfound wealth.

The one area of the economy that has been most responsive to the BoC's policy actions has been the real estate market. When the BoC hit pause in January 2023, we saw a surge in real estate activity in the spring, sending the market decisively back into sellers' territory. But once the BoC started hiking again in June, mortgage rates started to rise, pushing would-be buyers to the sidelines. Today's data confirm a continuation of that trend, with sales down another 4.1% month-on-month in August. With the rise in listings bringing greater balance to the market, house prices dropped 2.3% on the month, and 5.2% in the last three months.

While there has been a clear slowing in spending, employment, and the real estate market, the better financial position of Canadians and stubbornness of inflation make the BoC's job more challenging. And although we don't think the BoC needs to raise rates again this year, the Bank will likely keep the door open in case economic data surprise again to the upside.

• • Federal Reserve could be cautious as data continues to show economic resilience
  • BoE may raise rates for the last time in this cycle

• BoJ eyed for more clues on interest rates after recent hints

US

The main event of the week will be the September FOMC meeting. Powell and Co. are expected to keep rates steady but may still signal one more rate increase is coming.  Too many upside surprises with service/jobs/consumer readings will keep the Fed upbeat on the economy, forcing them to revise up their GDP forecasts and to price in one more rate hike.

Investors will also pay close attention to a steady dose of housing data.  On Tuesday, the release of both building permits and housing starts should show the housing market is stabilizing. On Thursday, weekly jobless claims are expected to show the labor market slowdown is slowly happening and existing home sales are steadying.   The key economic release of the weak is the flash PMIs, which are expected to show the economy is losing momentum.

Eurozone

The ECB probably brought an end to its tightening cycle at its September meeting but it doesn’t end there, with traders now switching their focus to when the easing cycle will begin. Lagarde was keen to stress that they could hike again if necessary but the likelihood is that they won’t.

Final HICP inflation data will be of interest on Tuesday, although revisions are not common and when they do happen, they’re usually small. Flash PMIs at the end of the week for the eurozone, Germany, and France will also be eyed.

UK 

It feels like a pivotal week for the UK, with inflation figures for August being released on Wednesday, one day before the Bank of England rate decision. While the central bank is believed to be near the end of its tightening cycle – in part due to the comments from policymakers in front of the Treasury Select Committee recently – one more on Thursday looks highly likely.

And the inflation data a day earlier is not expected to complicate the discussion, with the headline CPI seen rising to 7.1% – driven by energy prices as we’ve seen elsewhere – and the core reading falling slightly to 6.8%. I can’t imagine that will inspire a majority to declare job done or even consider pausing just yet. Retail sales and flash PMIs will also be released on Friday.

Russia

A quiet week following the CBR meeting on Friday, at which the central bank raised the Key Rate by another 100 basis points to 13%. Resurgent inflation and a slumping rouble is driving the central bank’s tightening efforts and more may be needed. PPI data on Wednesday will be eyed for signs of price pressures cooling, something we haven’t seen much of yet. We’ll also hear from various CBR policymakers throughout the week which will be interesting under the circumstances.

South Africa

The SARB is one of the few central banks that is not expected to raise interest rates next week, with the Repo Rate seen staying at 8.25%. Inflation data released a day earlier could spark a more lively debate but with headline and core both at 4.7% – well within the 3-6% target range – it probably won’t change the outcome. Retail sales figures will also be released on Wednesday.

Turkey

The CBRT meeting on Thursday brings a wide array of possibilities. Markets are expecting another 5% rate hike, taking the Repo Rate to 30% but expectations will vary massively. With inflation at almost 59% and the lira near record lows, there’s clearly a lot more to do to clean up the mess left by the previous Governor.

Switzerland

Inflation is back below 2% – 1.6% in August – and yet the SNB is widely expected to raise interest rates by 25 basis points on Thursday. It’s expected to be the final hike in the cycle, leaving the Policy Rate at 2%, with the first cut not priced in until late next year.

China

The only data to focus on will be the PBoC decision on the 1-year and 5-year loan prime rates on Wednesday. After they left the 1-year medium-term lending rate unchanged at 2.50% on Friday following a reduction on the commercial banks’ reserve requirements ratio by 25 basis points, it is likely that the 1-year and 5-year loan prime rate rates will remain unchanged at 3.45% and 4.2% respectively.

Chinese economic data recently has started to improve. Retail sales in August rose 4.6% y/y, above the consensus of 3%, and surpassing July’s 2.5%; the strongest pace of growth since May. August’s industrial production also managed to beat expectations of 3.9% with a growth of 4.5% y/y; the highest reading since April.

All things considered, the latest set of economic data suggests that the risk of a deflationary spiral in China has abated by another notch.

India

No key data releases.

Australia

On Tuesday minutes of the recent RBA meeting will be released. At the last monetary policy meeting, the RBA extended its interest rate pause at 4.1% for the third consecutive meeting. Market participants will be looking for more clues on whether there will be further hikes after the latest jobs data rebounded following a surprise drop in July.

Next up, flash services and manufacturing PMIs for September will be released on Friday. A deeper contraction in the services PMI is expected, falling to 46.5 from 47.8 in August. That would be the third consecutive month of contraction in the services sector. Meanwhile, manufacturing is expected to remain almost unchanged at 49.5 versus 49.6 in August.

New Zealand

Two key data releases to take note of. Firstly, Q2 GDP on Thursday could see a dip to 1.2% y/y from 2.2% in Q1. That would be the weakest annualized quarterly growth since Q2 2022.

Balance of trade data for August is due on Friday with the trade deficit expected to narrow slightly to NZ$-0.9 billion from NZ$-1.11 billion in July. Imports are seen falling to NZ$6.1 billion from NZ$6.56 billion recorded in July.

Japan

A pivotal week with inflation data and the Bank of Japan’s monetary policy decision. After BoJ Governor Ueda’s recent “quiet exit” comment from the current ultra-easy monetary policy stance, expectations for an earlier exit have dialed up with the first interest rate hike seen as early as Q1 2024.

Therefore, the upcoming inflation numbers for August out on Friday will be scrutinized closely. The core inflation rate is expected to be almost unchanged at 3% y/y versus 3.1% in July. That would be the eighteenth consecutive month that it exceeds BoJ’s target of 2%. Interestingly, the core-core inflation rate (excluding fresh food & energy) is expected to accelerate further to 4.4% y/y in August from 4.3% in July.

The BoJ’s monetary policy decision will be on the same day. No change is expected after the “flexible” yield curve control policy on the 10-year JGB yield was enacted at the previous meeting. No release of the latest economic forecasts for Japan, hence all ears will be on Ueda’s press conference for hints on how confident he is on the inflation trajectory.

Singapore

Balance of trade data for August will be out on Monday with export growth expected to be still in contractionary mode albeit at a slower pace, -15.8% y/y from -20.2% in July. This would be the 11th straight month of contraction.

Economic Calendar

Saturday, Sept. 16

Economic Events

• Global Geothermal Conference in Beijing
• Informal meeting of EU finance ministers concludes in Spain

Sunday, Sept. 17

Economic Events

• No major events

Monday, Sept. 18

Economic Data/Events

• US cross-border investment, NY Fed services business activity, NAHB housing market index
• Canada housing starts
• Singapore trade
• Russian and Chinese foreign ministers to talk in Moscow
• RBA Deputy Governor Bullock becomes central bank chief
• German Finance Minister Lindner speaks at the Bloomberg Future of Finance Conference in Frankfurt
• Ukraine defense ministers meet in Germany

Tuesday, Sept. 19

Economic Data/Events

• US housing starts
• Canada CPI
• Eurozone CPI
• Mexico international reserves
• RBA releases minutes of this month’s policy meeting
• General debate starts at the United Nations’ 78th general assembly
• OECD releases interim economic outlook report on the global economy
• New Zealand PM Hipkins debates National Party leader Christopher Luxon
• ECB’s Elderson addresses conference at Goethe-Universität/Center for Financial Studies in Frankfurt
• BOC Deputy Governor Kozicki speaks at the University of Regina
• EU European affairs ministers to meet in Brussels

Wednesday, Sept. 20

Economic Data/Events

• FOMC Rate Decision: Expected to maintain benchmark lending rate target at 5.25% to 5.5%
• China loan prime rates
• Eurozone new car registrations
• Japan trade
• South Africa retail sales, CPI
• UK CPI
• Bank of Canada issues summary of this month’s policy meeting
• ECB’s Elderson speaks at Springtij Forum 2023 in Netherlands
• FedEx reports earnings

Thursday, Sept. 21

Economic Data/Events

• US leading index, initial jobless claims, existing home sales
• BOE Rate Decision: Expected to raise rates by 25bps to 5.50%
• Eurozone consumer confidence
• New Zealand GDP
• Norway rate decision: Expected to raise rates by 25bps to 4.25%
• South Africa rate decision: Expected to keep rates steady at 8.25%
• Spain trade
• Sweden rate decision: Expected to raise rates by 25bps to 4.00%
• Switzerland rate decision: Expected to raise rates by 25bps to 2.00%
• Turkey rate decision: Expected to raise rates by 500bps to 30.00%
• ECB’s Schnabel speaks at the ECB Annual Research Conference
• ECB chief economist Lane addresses Money Marketeers of New York University in New York

Friday, Sept. 22

Economic Data/Events

• US Sept flash manufacturing PMI: 47.9e v 47.9 prior; Services PMI: No est v 50.5 prior
• Australia manufacturing PMI, services PMI
• Canada retail sales
• European flash PMIs: Eurozone, Germany, France, and the UK
• Japan BOJ rate decision: No change expected with rates, to keep ultra-easy policy
• Japan CPI and preliminary PMIs
• New Zealand trade
• Spain GDP
• Taiwan jobless rate
• ECB VP de Guindos addresses online event
• China’s Bund Summit
• Atlantic Council’s “Transatlantic Forum on GeoEconomics” in Berlin, with German Economy Minister Habeck and others
• Riksbank Governor Thedeen speaks on “Why is the Swedish krona so weak” in separate events

Sovereign Rating Updates

• Germany (S&P)
• Poland (Moody’s)
• Finland (DBRS)
• France (DBRS)

Monday, Sep 18, 2023

Tuesday, Sep 19, 2023

Wednesday, Sep 20, 2023

Thursday, Sep 21, 2023

Friday, Sep 22, 2023

The U.S. Federal Reserve is widely expected to hold the Fed funds rate at the 5.25-5.5% range next week. U.S. economic growth data remains exceptionally strong with GDP growth tracking a 3%+ rate in Q3 and employment is rising solidly. Still, job openings and quit rates have continued to trend lower, suggesting labour demand is continuing to soften under the surface. Indeed, the unemployment rate ticked up to 3.8% in August. More important, interest rates are now at levels ‘restrictive’ enough to cool the economy and inflation pressures have moderated significantly. The Fed remains firmly focused on the data and won’t hesitate to lift the interest rate again if necessary (particularly if inflation shows signs of reaccelerating). But not next week.

The Bank of Canada is also watching inflation closely with August CPI data to be released next week. As in the U.S., higher energy prices will push headline price growth higher. We expect a 3.7% year-over-year rate in August, up from 3.3% in July. Grocery prices will remain high, but the pace of growth has been edging lower. And mortgage interest costs will continue to drive a disproportionate share of overall price growth (this accounted for over a quarter of total year-over-year price growth in July by our count.)

The BoC is more concerned about where price growth is going rather than where it’s been. And more recent broader measures of inflation pressure are a better indicator of that. The BoC’s preferred core measures may tick higher on a year-over-year basis due to soft year-ago ‘base-effects’ (the month-over-month increase in those measures a year ago was relatively small). But it’ll be more focused on the recent 3-month average growth rate for the ‘median’, ‘trim’, and trim services ex-shelter (sometimes called ‘super core’) measures. All of these are still ‘sticky’ at rates above the top-end of the BoC’s inflation target. But we continue to expect signs of softening in the economy to spill over into softer price growth over the remainder of the year—preventing additional BoC interest rate hikes.

Week ahead data watch

We expect July Canadian retail sales to show minimal change from the prior month, in line with Statistics Canada’s preliminary estimate of +0.4%. By our count, auto sales declined on a seasonally-adjusted basis in each of July and August, suggesting some downside risk to near-term retail sales.

The inflation target has been met for 16 consecutive months but the reflation narrative has lost some steam recently.

We think the data supports another tweak of the yield curve control (YCC) this year, most likely in October, as one last step ahead of completely dismantling YCC.

We expect enough reflation traction for the BoJ to hike its policy rate to zero in Q2 2024. However, we think there is a long way to a situation where the BoJ can tighten much further than that.

We forecast USD/JPY towards 130 on 6/12M horizon, primarily as we deem long US yields are at (or around) peak and that the global environment favours the JPY.

Full report in PDF.

• Central bank decisions in United States, United Kingdom, Japan, and Switzerland
• Fed almost certain to hit pause, markets will focus on updated rate projections
• More scope for surprises from Bank of England and Swiss National Bank instead

Fed - mind the dots

The central bank bonanza will kick off with the Fed on Wednesday. Markets are pricing in almost no chance of a rate increase, following several remarks from FOCM officials calling for patience and more time to examine incoming data before making their next move.

As such, the market action will most likely come from the updated economic forecasts and the interest rate projections in the new ‘dot plot’. Specifically, will the Fed continue to signal another rate increase this year and how many rate cuts will it telegraph for next year?

The latest projections showed interest rates closing next year at 4.6%, projecting roughly 100bps worth of rate cuts from the anticipated peak. But given the streak of robust economic data lately and signs the US economy is not cooling off, the risk is that policymakers signal fewer rate cuts this time.

Economic growth seems to have reaccelerated over the summer, with some help from resilient consumer spending and a labor market that’s beyond most estimates of full employment. With energy prices soaring as well, inflationary pressures are unlikely to die out. Therefore, this might be a meeting where the Fed cements the notion that rates will remain higher for a longer period of time, adding fuel to the rally in US yields and the dollar. 

Overall, the outlook for the dollar seems bright as the reserve currency offers a unique combination of solid economic fundamentals, attractive interest rates, and safe haven qualities. That stands in contrast to the rest of the FX arena. Europe and China are plagued by a severe economic slowdown, the yen has been demolished by the Bank of Japan’s refusal to exit negative rates, and sterling is vulnerable to shifts in global risk sentiment.

BoE decision could be a close call

Over in the UK, the Bank of England will unveil its own decision on Thursday and traders assign a 70% probability to a rate increase. Recent data releases have been mixed, showcasing a sharp slowdown in growth and a weakening labor market. However, inflationary pressures remain hot, creating a dilemma for BoE officials.

Economic growth was stagnant in July from a year earlier, and business surveys point to a contraction ahead. Similarly, employment trends are moving in a negative direction. The labor market lost jobs in July, a phenomenon that will likely persist according to leading indicators.

And yet, wage growth accelerated in July, reaching 8.5% in annual terms. That’s a sign that inflation is unlikely to cool anytime soon, hence the dilemma for policymakers. Raising rates further would help bring inflation down, but it might also choke growth completely and push the economy into recession.

Therefore, the vote count for this decision will likely be split. Recent remarks from BoE officials suggest a rate increase is the more likely outcome, but it might be a closer call than markets expect.

As for sterling, the risks seem tilted to the downside. If the BoE raises rates the currency could initially spike higher, although any upside reaction might be minor as this is the market’s baseline scenario already, and reverse quickly if the vote is split and there’s no clear commitment to further hikes. And if the BoE doesn’t hike, that would be a huge surprise, pushing the pound lower instantly.

On the data front, the inflation stats for August will be released ahead of the BoE meeting on Wednesday, while the latest batch of business surveys is scheduled for Friday.

SNB and BoJ meetings

The Swiss franc is the best performing currency of 2023, with the British pound close behind. Driving this stellar performance was the Swiss National Bank’s exit from negative interest rates and FX interventions to strengthen the franc, alongside some quiet safety flows, courtesy of the darker growth outlook in the Eurozone.

SNB officials meet on Thursday and there’s a 60% probability they raise rates. Hence, there’s uncertainty on whether they will pull the trigger, as the Swiss economy has started to lose momentum and inflation was running at only 1.6% in August. Still, the central bank expects inflation to reaccelerate amid rising electricity and rent prices, and the recent spike in energy costs will likely reinforce their view.

Because of this inflation assessment, the SNB seems more likely to raise rates, potentially boosting the franc on the decision. That said, it might be the final rate increase of this cycle, as inflation is mostly under control.

Crossing into Japan, there isn’t much scope for any shifts when the central bank meets on Friday. The Bank of Japan already recalibrated policy back in July and will most likely take the sidelines this time while it monitors the effects of its previous actions.

But despite the BoJ’s tightening move, the yen has continued to lose ground, suffering at the hands of rising US yields and soaring energy prices. Dollar/yen is currently testing its highest levels of the year, and a combination of a slightly hawkish Fed alongside a BoJ that maintains its loose stance next week may be the catalyst for a break.

Finally, it’s a busy week in terms of data releases. The highlights will be the S&P Global PMIs for September, due on Friday. Markets will pay special attention to the Eurozone prints, amid signs the economy is slipping into recession. The latest batch of Canadian inflation stats on Tuesday and New Zealand’s GDP on Thursday will also be in focus.

This week, the ECB delivered a 25bp hike which, combined with a dovish message, we see as a compromise in a stagflationary-ish environment. We were quite surprised by the limited optionality for further hikes in the statement, although Lagarde naturally refused to write off the possibility. We see the ECB's approach now focusing much more on the time horizon for rates being in restrictive territory. As the new staff projections kept the forecast for headline and core inflation in 2025 above 2%, the road to neutral rates could end up being a long one. Our baseline is for the ECB to abstain from further hikes, and we see the next move being gradual cuts starting in the summer 2024 (see Flash ECB Review Confirmed: A final rate hike, but restrictive policies are not over, September 14).

Next week, focus turns to Federal Reserve which we expect to keep rates unchanged despite an upside surprise in August core CPI this week. The uptick in core was driven by faster services inflation, particularly airfares, but overall, underlying price pressures seem to have remained slightly higher than anticipated in early Q3. In this context, we think markets will keep a close eye on how FOMC participants assess the need for later hikes. In June, 12 out of 18 dots looked for one more hike, but we doubt it will materialise. Markets have bought into the 'higher for longer' narrative, and in our view, the consequent tightening in financial conditions limits the need for further hikes (see Research US: Fed preview - Plotting the way forward, 15 September).

We believe the Riksbank will deliver one final rate hike next week, as core inflation is still too high, and they want to be sure they are not relaxing monetary policy too early. Weaker SEK fuels inflation for imported products, and hence, Riksbank cannot deviate too much from ECB's policy. Luckily for Riksbank, this time, ECB's dovish hike weakened the euro versus the hard-hit Swedish krona. Also in Sweden, rates will remain high for some time, and we do not expect rate cuts until Q2 next year. Starting in Apr-2024, we expect 25bp cut at each meeting, taking the policy rate to 3.0% by year-end.

We also expect both Norges Bank and the SNB to deliver their final 25bp hikes next week accompanied, and we expect this to mark the peak for both central banks. For Bank of England, we also expect a 25bp hike to 5.50% but the August CPI print ahead of the meeting could prove decisive.

We expect no changes in monetary policy by Bank of Japan next Friday. We do however expect another tweak to YCC later this year. On Thursday, the People's Bank of China (PBoC) announced a 25bp cut to the reserve requirement ratio for most banks. They also injected a net CNY191bn into the financial system through 1-year policy loans while keeping the lending rate unchanged. We see room for further policy support, if needed, to counter problems in the country's real estate sector.

In terms of data releases, next week's focus will be on September preliminary PMIs from euro area and the US on Friday. While global manufacturing has been in a contractionary territory for 12 consecutive months, service sector has kept the engine running, but in August, euro area service PMI fell below 50. We also expect modest weakening in the US driven by service sector.

Full report in PDF.

GBPUSD bears slowed on Friday but hold grip and point to further weakness, following a 0.6% drop on Thursday.

Adding to negative signals was break below 200 DMA (1.2431) for the first time since early March, with Friday’s close below it, to reinforce bearish structure.

Fresh extension lower probed below 1.2400 handle after 3 ½ months, eyeing target at 1.2310/04 (May 26/25 higher base) test of which to mark full retracement of 1.2307/1.3141 rally.

South-heading 14-d momentum is deeply in negative territory and MA’s in full bearish setup, contributing to negative outlook.

Traders turn focus on UK inflation report (Aug CPI m/m 0.7% f/c vs -0.4% in July; core m/m Aug 0.7% f/c vs July 0.3%) due on Wednesday and BOE policy meeting on Thursday.

Markets widely expect the central bank to deliver another 25 basis points hike (15th consecutive rate increase) and push the interest rate to 5.5% but expect that this would be the last in the hiking cycle and anticipate a dovish shift in BOE’s expectations.

The pound would be further deflated in such scenario, with initial risk of violating 1.2200 level and possible deeper drop on firmly dovish MPC.

However, this should not be seen as done jobs, as inflation in UK remains elevated (still the highest among the G7 group) and forecasts point to fresh rise in August, which would influence central bank’s plans for coming months.

Res: 1.2431; 1.2482; 1.2504; 1.2547.
Sup: 1.2388; 1.2368; 1.2307; 1.2269.

Markets

Yesterday’s ECB assessment that rates being kept at current level ‘for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target’, understandably caused markets to conclude that the hiking cycle might be over. With markets looking forward by nature, the question on the timing of the first rate cut is looming on the horizon. This yesterday resulted in a mild decline in yields. However, even in a forward looking attitude, it is simply too early to play the U-turn in the euro interest rate cycle. Lagarde already said she couldn’t confirm that ECB rates had reached their peak. An FT article also suggested that ECB hawks still see the December meeting/projections as a new point of evaluation. If inflation or wage pressures stay too high a rate hike might still be discussed. ECB’s Vasle today indicated that the current rate level also opens more space to debate to discuss QT/an acceleration the reduction of the APP portfolio. This idea in theory supports the case for some curve steepening. This is what happened today. German yields rose between 4.5 bps (2-y) and 7.6 bps (30-y). This doesn’t look like a market that is already focused on the timing of a rate cut. After yesterday’s rise, US yield gains are lagging the rise in EMU. Still, US data confirmed the economic resilience. The Empire Manufacturing survey of the New York Fed unexpectedly returned into positive territory (1.9 from -19), with a sharp rebound in shipments and orders. Price indices also remained at elevated levels. Another report showed US import prices rising 0.5% M/M due to higher petroleum prices. Admittedly, these are not the most important data and they won’t change the Fed’s assessment at next week’s meeting. Even so, they are strong enough to keep bonds in the defensive with US yields rising between 1-3 bps across the curve. The US 10-y yield (4.32%) is only a whisker away from the cycle top at 4.34/4.36%. After finishing this report Consumer confidence of the University of Michigan (especially the inflation expectation measures) still has market moving potential. The EuroStoxx50 initially gained up to 1.0%  building on WS gains and a positive sentiment in Asian after some hopeful figures out of China. However, momentum dwindled as US traders joined (EuroStoxx50 currently +0.6%; S&P 500 even opened with a loss of 0.35%).

In FX, the dollar rally shifted into a lower gear, but there is no sign at all that any meaningful correction might be on the cards. EUR/USD stabilized in the 1.0635/1.067 area. The 1.0635 support is far from save. The DXY is holding well north of 105. (105.37). USD/JPY set a minor YTD top just below 148. Markets are looking out for a potential policy reaction (or the absence of it) as the BOJ meets next Friday.

News & Views

The Turkish central bank (CBRT) is making it more expensive for local banks to offer short-term deposit schemes to clients under the KKM program. KKM is an initiative introduced in late 2021 via which Turks can deposit their liras (TRY) on accounts that offer a certain interest rate. If TRY losses would surpass the interest received on the deposit, the government compensates for the difference. It dampened the incentive to swap ever depreciating liras for FX, including the dollar, and turned out to be instrumental in containing further losses for the currency. The downside, however, is that it is draining state finances. The CBRT now decided to lift the amount of money that banks must hold as reserve by raising the reserve requirement ratio from 15% to 25%. This will drain TRY liquidity from the market (as banks hold more reserves) but the move risks losing efficacy if consumers start swapping the liras that no longer can be deposited under KKM again. USD/TRY today marginally gains to 26.98, further erasing losses after the shocker interest rate hike by the CBRT end of August. USD/TRY back then briefly traded below 26.

In its quarterly survey, the Bank of England finds that public trust in the institution has fallen to the lowest level since conducting the questionnaire in 1999. 40% of the respondents think the central bank is doing a bad job, up from 24% in May. This compares to less than one in five being satisfied with the BoE. The survey also gauges consumers for their inflation expectations. Those for the year ahead rose from 3.5% to 3.6%, well above the 2% BoE target. Consumers see inflation two years ahead at 2.8%, up from 2.6% in the May survey. It’s bad news for the central bank. Threadneedle Street meets next week Thursday. Markets have rapidly pared tightening bets over the past few weeks amid weakening economic data. They do expect at least one (but less than two) more rate hike(s), but not necessarily at the September meeting (70% chance discounted).