Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Chief Investment Strategist
Summary: The bumpy disinflation on the services side became evident in US September CPI report, and Fed rate hike bets for the balance of the year have picked up. USD strength returned, and despite limited room on the upside, dollar strength could prevail. Risk-sensitive AUD is hurt on yields and weakening RBA rate hike bets, while CNH and SGD responded little to data out today and room for appreciation remains limited.
The US inflation print yesterday was hot again. Headline inflation came in above expectations, but still cooled from August as it printed 0.4% MoM exp. 0.3%, prior 0.6%) and 3.7% YoY (exp 3.6%, prior 3.7%). Meanwhile, the core rate, which excludes food and energy, came in at 0.3% MoM and 4.1% YoY as expected. While headline gains could be underpinned by energy and base effects, it was the rise in shelter and the core services inflation (0.6% MoM from 0.4% prior), as shown in the chart below, that garnered a hawkish reaction in the markets. Shelter prices, which make over 30% of the overall CPI index, rose higher due to the travel demand and added to the upside from car insurance and recreational services. While disinflation in goods continued, services disinflation has been bumpy due to the impact from summer demand and mega entertainment events driving the US economy in the last few months.
The market reaction is warranted by the recent moves in the bond market with the 10-year Treasury yields having dropped 25bps since the end of last week given geopolitical worries and the dovish turn in Fed speakers. Many Fed speakers, including some of the hawks like Waller, have recently highlighted that the recent rise in bond yields could be substituted for a Fed rate hike, suggesting they may stay away from voting for another rate hike at the November 1 meeting. Marlet pricing for a Fed rate hike had dipped to sub-30% levels as a result, but is now back to 40% with the hot CPI print last night.
As noted above, with services inflation driven by one-off event spending and summer travel, we continue to expect a pullback in spending going into the end of the year. Consumers are likely feeling the pinch from high interest rates, as suggested by all-time highs in credit card borrowings. High real rates will likely have some fallouts for businesses and consumers, and this suggests that the Fed could continue to stay on hold. Also, the unfortunate war situation in Israel further adds to volatility and risks, suggesting that the Fed could decide to wait on the sidelines. Today’s University of Michigan sentiment report could be key for inflation expectations, and Fed Chair Powell speaks next week.
The US dollar’s DXY index jumped back above the key 106 level on the upside surprise in US inflation, which boosted the probability of a Fed rate hike by the end of the year. As the progress on inflation remains bumpy, dollar continues to be a buy on dips. As we have noted before, dollar strength on the right side of the USD smile could be more sticky. In addition to US exceptionalism, the dollar’s carry as well as its hedging use, also continue to make it attractive and it remains hard to find alternates. A clear turn in the US economic momentum will be needed to see a turnaround in the dollar, but still expect it to remain supported. Dollar’s carry could look less attractive if intervention threats in JPY continue to get louder, or if real interventions are seen.
As bond yields remain the key story in markets, yield-sensitive FX pairs should remain on watch. USDJPY continues to be a buy on dips amid the divergence in US and Japanese monetary policy, but the 150 level is now serving as the line in the sand for speculators. AUD has lately been more vulnerable to rising yields, given the lack of support coming from China and paring back of the RBA rate hike bets although September labor data due 19 October and quarterly CPI report due 25 October could be key.
China data today showed risks of deflation still remain with demand remaining subdued. CPI was flat YoY (vs 0.1% YoY and 0.2% expected) and PPI showed a larger-than-expected decline of 2.5% YoY (-3.0% last and -2.4% expected). The slump in September exports and imports eased, but the outlook remains muddled by expected weakness in global demand and property sector crisis keeping domestic demand rebound in check as well. There were also some announcements this week on supporting the stock markets, including reports of a state-backed stabilization fund. The yuan, however, reacted little and consolidated this week and USDCNH trades around 7.31 with upside risks to 7.33 if another leg of dollar strength comes through.
Singapore reported Q3 GDP growth and MAS policy decision today. The economy grew 0.7% YoY in 3Q23, rising 1.0% QoQ to beat market expectations of 0.4% YoY and 0.6% QoQ growth. Manufacturing activity remained a drag, although that was offset by 6.0% YoY growth in construction and 1.9% YoY growth in services. Although Q3 GDP growth momentum was strong, the outlook for global demand turning tepid could weigh increasingly on exports and challenge the near-term growth outlook. The recovery in China also remains tepid and the ongoing conflict in Middle East could add to the volatility in energy prices, suggesting more headwinds and full-year 2023 could fall near the lower end of MAS’ 0.5-1.5% forecast range.
Given these risks, the Monetary Authority of Singapore kept the policy settings unchanged, retaining the slope, mid-point and width of the SGD NEER currency band. As noted in our preview, inflation faces threat from rising food and energy prices as well as the further GST increase set to go in effect in 2024. Meanwhile, the MAS also announced that it would be conducting policy meetings on a quarterly basis beginning in 2024. The MAS will meet in January, April, July and October. The increase in frequency for MAS decisions will allow them to respond to global economic shifts in a more appropriate manner without the need for inter-meeting surprises. USDSGD remained capped below 1.37 following the announcement but unable to move below 1.3680. Room for appreciation in the SGD remains limited due to the strength of the US dollar as discussed above, and SGD also trades near the upper end of the MAS policy band. USDSGD could continue to find support at 50DMA of 1.36.