Week Ahead: US CPI to Temper Aggressive Fed Rate Cut Speculation, French Political Intrigue and Possible Downgrade, while ECB Stands Pat

[Ben Graham]

The poor US employment data fanned speculation of a 50 bp rate cut when the Fed meets on September 17. Even though more unwelcome news from the labor market is expected with next week's BLS annual benchmark revisions that could wipe out 500k-1 mln jobs (the adjustment last year was 818k lower), the risk of a large Fed cut may be exaggerated. An acceleration in headline CPI (September 11) may temper the enthusiasm for a large move. 

The ECB meeting is on Thursday, and the staff will update economic projections. There is little doubt, but that central bank will stand pat. Political developments may be more important. The French government looks surely to lose a confidence vote on Monday. President Macron's most likely recourse is to appoint another prime minister and accept that there will not be the fiscal improvement he hoped for (to reduced deficit from around 5.4% this year to 4.6% in 2026). This risks a downgrade by Fitch at the end of the week, which already has its AA- credit on negative outlook. Japan's LDP will vote on Monday whether to have a leadership contest this year. Senior LDP officials have offered their resignation to take responsibility for the recent electoral losses, but the key is Prime Minister Ishiba. Meanwhile, despite firm wage growth, household spending was weaker than expected and the government's stimulus efforts are less certain. The odds of a BOJ rate hike this year have slipped below 50% for the first time in two months. 

US

Drivers: The prospect of a resumption of the Federal Reserve's easing cycle and efforts that erode the Federal Reserve's independence from partisan politics hang over the greenback's outlook. Firm inflation readings may temper the market's speculation of a 50 bp cut. 

Data: Following the soft August jobs report, the BLS will announce annual benchmark revisions on Tuesday, and they are expected to point to even weaker job growth earlier. Some surveys suggest between 500k and 1 mln jobs could be revised away. Last year's revision removed almost 820k jobs. The PPI and CPI on Wednesday and Thursday are likely to have risen a little more in August, but the shift in the balance of risks comes from the labor market slowdown. Price pressures do not stand in the way of removing more restrictiveness from the current monetary setting. The federal government's August budget balance will report on Thursday, as well. The government appears to be spending billions of tariff revenue as fast as it is being collected. The deficit in the first seven months was nearly $920 bln, down about $85 bln from the same year ago period. 

Prices: The Dollar Index was pushed below the August 22 low set in response to Fed Chair Powell's comments at Jackson Hole near 97.55. However, the low was marginal, less than 5/100 of an index point. With a 25 bp cut fully discounted for later this month, there does not appear much more room for the pendulum to swing as the employment report does not appear sufficient to secure a majority vote in favor of a 50 bp cut. The next area of chart support is around 97.30, then 97.00. The pre-jobs report high was near 98.25. This may offer the nearby cap. 

EMU

Drivers: The narrowing of the US two-year premium over Germany often coincides with a stronger euro and that premium recorded a new low for the year near 155 bp before the weekend. If the French government is toppled in this week's confidence vote, the euro may wobble, but President Macron is likely to find another candidate for prime minister, though parliamentary elections cannot be ruled out. What can be ruled out is a general election as term limits prevent Macron from running again. 

Data: The four large EMU members report industrial output this week, but the focus is on the ECB's meeting. There is little chance of a change in policy. The ECB's staff will present updated forecasts and this, alongside President Lagarde's forward guidance. We expect it to be limited and for her to recognize there is still easing in pipeline given the lagged effects of monetary policy. 

Prices: The euro rose to $1.1760 after the US jobs report, its highest level since late July before consolidating. The combination of French political intrigue, possible contagion, poor German data, the euro still looks rangebound as opposed to a trending market. Still, the late July high near $1.1780 and the multi-year high seen on July 1 near $1.1830 are the next targets. 

PRC

Drivers: Chinese officials have allowed the yuan's gains to accelerate in recent weeks. The dollar's reference rate has been lowered from CNY7.1586 at the end of June and CNY7.1496 at the end of July to CNY7.1030 at the end of August. Some suspect that officials are allowing the yuan to appreciate so that when it eases policy cushion for it. 

Data: China reports August trade and inflation figures this week. It seems clear that at least in the short-run, China has found alternative markets for its exports as US tariffs hit. The efforts to curb excess investment (involution) will take time to be felt and that could cut exports on the margins. Still, a reduction in investment as a percentage of GDP will boost the share of consumption. Still, price pressures remain feint and are not obstacles to further easing of policy. 

Prices: The dollar peaked last week near CNH7.15 and although it pulled back, it still finished slightly higher on the week that snapped a four-week slide. The year's low was set on August 29 near CNH7.1160 and this may be approached, but the PBOC seems to be signaling that it has had enough for now as it set the dollar's reference rate higher in four of last week's five sessions. While China's critics urge it to drive the currency higher, it is not clear that if one were to really advise Beijing, given the deflationary forces and the arguable need to provide more stimulus, that a significant currency re-valuation would be the go-to policy prescription. 

JAPAN

Drivers: The single most important driver of the yen's exchange rate appears to be changes in US interest rates. A dramatic event, such as an unexpected BOJ rate hike later this month, or some other exogenous shock could also loosen the relationship. 

Data: Japan data are unlikely to change the market's collective wisdom that a rate hike this month is highly unlikely. Revisions to Q2 GDP (0.3% quarter-over-quarter and 1% annualized) and July industrial production (initially estimated at -1.6%) will not move the needle, though GDP could be shaved after disappointing capex numbers. There is a strong seasonal pattern for the monthly current account. In June, it nearly always deteriorates from May (18 of 20 years) and always improves in July (no exception in the past two decades). The pattern with the narrower measure of the trade balance is less clear. It has worsened from June in the past four years and 13 of the past 20 years. 

Prices: The US 10-year yield fell from 4.30% on Tuesday after the US holiday on Monday and finished the week below 4.10%, its lowest level in five months. The drop in US rates after the poor employment report saw the dollar slump toward the week's low set at the start of the week near JPY146.80. Nearby support is seen in the JPY146.50-60 area, while the August low was closer to JPY146.20. But US rates may have approached a near-term bottom given the prospect of higher US CPI, the risk-reward may favor a dollar bounce. The swaps market discounts slightly less than a 50% chance of a BOJ hike this year, for the first time since early July and still the dollar posted its lowest settlement in over a month ahead of the weekend. 

UK

Drivers: Sterling seems to be driven now by the dollar's broad direction and aided by the widening rate premium the UK offers over the US (and Germany). There has also been a shift in expectations for the Bank of England. The odds of another rate have fallen from 100% on the eve of the last BOE meeting to 40%. Many, if not most, observers recognize the risk of that the government take new measures to boost revenue and a surtax on British banks has already been suggested as a possibility. The resignation of Deputy Prime Minister Rayner over a tax issue adds to Prime Minister Starmer challenges, while news of a seasonal adjustment problem by the ONS that exaggerated retail sales by as much as GBP2 bln complicates the fiscal pressure building on Chancellor Reeves. However, the weakness of the dollar was a more important driver and this helped lift sterling.

Data: The highlight comes at the end of the week: July GDP and details. One cannot simply extrapolate from the monthly to the quarterly figures. The cumulative monthly prints were 0.9% in Q1 and 0.2% in Q2 and the quarterly GDP prints were 0.7% and 0.3%. Economic growth this quarter may slow a little more. 

Prices: Sterling fell to four-week lows in the middle of last week slightly below $1.3335. It recovered smartly despite domestic problems and reached $1.3555 ahead of the weekend. That was sterling's best level since August 18. Nearby resistance is seen in the $1.3565-$1.3600 area. The upper end of that range was formed in July and August and looks formidable given the macro backdrop. 

CANADA

Drivers:  The Canadian dollar is sensitive to the broad direction of the US dollar. Last week, when the US dollar fell against most of the G10 currencies, the Canadian dollar was the only G10 currency unable to gain against the greenback. It also reported disappointed jobs data ahead of the weekend, which followed the recent poor Q2 GDP report (-1.6% vs. median forecast of -0.7%). 

Data: Canada's economic calendar is sparse with July building permits and Q2 capacity utilization rates at the end of the week. The Bank of Canada meets on September 17, and the odds of a rate hike has risen since the weak Q2 GDP. The swaps market now puts the odds of a cut around 73%, up from about 44% before the GDP and 56% before the jobs report. 

Prices:  The Canadian dollar looks vulnerable. The US dollar rebounded from a three-day low near CAD1.3760 in the initial spike after the US employment report to almost CAD1.3840. A move above CAD1.3850-60 could spur a move toward CAD1.3900 initially, but we suspect the risk may extend toward CAD1.40 in the coming weeks. 

AUSTRALIA

Drivers: The two main drivers of the Australian dollar are the broad direction of the Dollar Index and the Canadian dollar. The inverse correlation of changes between the Dollar Index and the Aussie is near 0.85 for the past 30 sessions, near the most since the middle of 2024 around 0.77 over the past 60 sessions. The inverse correlation with the changes in the Canadian dollar is near 0.82 and 0.78 for the past 30 and 60 sessions, respectively. The correlation with the offshore yuan is significant near 0.60 for both tenors. 

Data: Australia's economic calendar nearly bare, with a couple bank confidence surveys and the Melbourne Institute's survey of consumer inflation expectations. These are not the kind of data points that will sway market expectations for the central bank meeting at the end of the month. The bar to cut seems high. In fact, the futures market has downgraded the extent of the easing this year for the past six consecutive sessions. 

Prices: The Australian dollar was sold through $0.6600 on Tuesday last week but settled above it and held above it before rallying to almost $0.6590 ahead of the weekend. This is its best level since July 25. The most likely scenario seems to be one of consolidation rather than a break higher. Key support is seen in the $0.6480-$0.6500 area. 

MEXICO

Drivers:  Mexico's high interest rates (7.75% target) and liquidity make the peso an attractive long side of trades funded by a short dollar. The dollar has spent the first two months of Q3 in a fairly defined range of MXN18.50-MXN19.00. It does not look like it will be going anywhere quickly, but for most market participants it is only interesting near the extremes of the range. The central bank meets a week after the Federal Reserve, and it looks poised to cut rates too. 

Data: Given that scenario, the most important data point in the coming days is the August CPI (September 9). The headline and core rates are unlikely to change much from the July reading of 3.51% and 4.23%, respectively. 

Prices: The dollar briefly traded below MXN18.60 after the disappointing US employment report for the first time since August 25. It did not stay there long and recovered back to almost the MXN18.70 area where it was before the US jobs data before consolidating. This range affair looks set to persist, while the carry pays peso longs to sit tight. 

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