Bonds and stocks rallied in tandem worldwide last week on relief at the Federal Reserve’s caution regarding future rate increases, and a general sense that the fastest hiking cycle in history is now over. A soft nonfarm payrolls report out of the US on Friday added fuel to these hopes, and nearly every major currency worldwide rallied sharply against the US dollar, as investors celebrated and poured into risk assets. Commodity exporting countries, particularly the Latin American ones, were conspicuously among the winners, while the traditional safe havens such as the Japanese yen and the Swiss franc lagged badly. With the major central bank meetings now out of the way, it is clear that the major part, if not all, of the hiking cycle is now over. Attention now shifts to how soon and how far interest rates will be cut, though none of them seem to be in a hurry to do so. This week will be unusually data-light in the major economic areas, so currency markets should be mostly driven by the aftershocks of last week’s Fed dovishness and tentative evidence of a labour market slowdown in the US.
While the Bank of England kept rates unchanged last week, as was universally expected, the MPC failed to validate the market´s dovish expectations. The vote was split 6-3 in favour of no change, which we see as moderately hawkish given that some investors were bracing for a larger consensus in favour of no change, and perhaps one vote in support of an immediate cut. The BoE expressed worry about high wage growth and inflation stickiness, and pushed back against the prospect of rate cuts any time soon, supporting our stance that the committee is comfortable adopting a ‘Table Mountain’ approach to rates, rather than one that resembles the ‘Matterhorn’. Heightened expectations that Bank of England rate cuts remain a long way off helped sterling outperform the euro last week. The focus this week will be on the preliminary third-quarter GDP report, out on Friday. Economists are pencilling in a minor contraction in activity that, if confirmed, may raise concerns over the possibility of a technical recession as early as the second half of this year.
The common currency rebounded sharply last week, amid the general flight from the dollar. However, the move lacked any Eurozone-specific catalyst. The PMIs of business activity remain consistent with a stalling or even shrinking economy, and the more lagging indicators like retail sales or industrial production do not seem to disagree. On the plus side, inflation has fallen faster than expected and the ECB has been able to stop the hiking cycle at a relatively modest 4%, which should, to an extent, limit the squeeze on household incomes and business activity. We think there is room for euro appreciation over the medium-term, given the cheapness of the currency and the low expectations about economic growth that are currently priced in. We’ll have to wait a little bit longer for the preliminary Q3 GDP numbers, which won’t be released until next Tuesday. In the meantime, Wednesday’s September retail sales should provide us with a decent and timely gauge as to the state of consumer demand in the common bloc.
The Federal Reserve suggested last week that the threshold for any further hikes in the US is higher than markets had expected, and that the balance of probability is that this hiking cycle is over. A softer-than-expected payrolls report on Friday certainly helped sentiment further, and markets were off to the races. The October job creation number missed its mark by 30k, while there were also downward revisions that totalled over 100k in the August and September numbers. More important, in our view, is that we are finally beginning to see signs of an easing in US wage pressures, which should ease concerns over the second-round impact on inflation. Markets are starting to price cuts as early as May 2024, which strikes us as somewhat aggressive. We would probably need to see both a much more substantial deceleration in the US economy than we have seen so far, and a few downside surprises in inflation, for such a timetable to be realised. It is also worth noting that, despite the recent cooling, the labour market remains rather healthy, as evidenced by low jobless claims and an increase in job openings.