Week Ahead: Impasses Between US and China and Between Republicans and Democrats

[Redator]

There are several moving pieces in the broad macro story that are not going to be resolved in coming days. Although President Trump is playing down a "trade war" with China, it is difficult to see the basis for a deal when he meets with China's Xi at the end of the month in South Korea. The US is not about to relax its chokehold on advance semiconductor technology or allow subsidiaries of sanctioned Chinese companies to provide a loophole. Nor does it appear likely that Beijing would jettison its export licensing requirements for rare earths, processing technology, and EV battery technology. It also does not seem that either side is prepared to backtrack on its port fees levied on the other. The US federal government remains largely shut, and the path to re-opening remains elusive. A federal court has blocked the "reduction in force", permanent dismissals. 

The fraud-related write-downs at two regional US banks, on the heels of the collapse of Tricolor and First Brands that adversely impacted several large investors, was a shot across the bow. It is a useful reminder of the unresolved risks emanating commercial real estate. Office loan delinquencies have reached 10.4%, approaching 2008 levels. Around $1 trillion of CRE loans must be refinanced before year end, according to industry reports. With its gain about 1.8% before the weekend, the KBW Regional Bank Index fell by around 1.6%% last week. It has fallen for four consecutive weeks, which is the longest losing streak this year. The week ahead highlights include US CPI (yes), Japan's Diet selects a new prime minister, China reports Q3 GDP and holds the 4th plenary session to frame the next five-plan. The preliminary October PMI will also be released. 

US

Drivers:  With what seems to be the end of the fragile and tentative trade truce between the US and China, the average effective US tariff is likely to jump by 8-13 percentage points depending on if the reciprocal product exemptions remain. The market recognizes this as a headwind for the US economy. The futures market has a Fed cut full discounted for later this month and in December and has begun to rethink the possibility of a 50 bp cut at one of the last two meetings of the year. The large write-offs at two regional banks brought back to the fore late-cycle credit fears. The commercial real estate (CRE) market remains at the epicenter. CRE loans account for an estimated 44% of regional bank portfolios compared with around 13% for large banks. Office loan delinquencies are near 10.5%, approaching 2008 levels. Over $1 trillion of CRE loans need to be re-financed by year-end according to some estimates. 

Data: With the federal government still closed, regional Fed surveys, the preliminary October PMI, and existing homes sales are on tap. However, at the end of the week, the BLS has said it will report the September CPI. The exception is being made because of the importance of the report in setting the cost-of-living adjustment for government programs, including social security. Still, with many Fed officials, though clearly not all, wanting to look through what is thought to be tariff-induced price pressures, main focus remains on the labor market. That said, headline CPI is rising at a 2.4% annualized pace through August, though the increase in Q3 looks to be more than in Q1 and Q2.

Prices: The Dollar Index settled on October 10 slightly below 99.00. It was sold to almost 98.00 at the end of last week. The rally from the multi-year low set when the Fed cut interest rates on September 17 (~96.20) to around 99.50 ended. With last week's pullback, the Dollar Index approached the (50%) retracement found near 97.90. It recovered to 98.55 before the weekend. Nearby resistance is in the 98.60-75 area. The daily momentum indicators are turning down in over-bought territory. 

EMU

Drivers: The mainstream narrative cast Europe as being squeezed between Russia's hybrid warfare tactics, and nationalistic US, and China's rare earth dominance. The euro itself is caught between poor German (and French economic data) and the escalation of US-Chinese tensions. The euro's inverse correlation over the past 30- and 60 sessions with the US two-year yield is greater than the inverse correlation with changes in the two-year spread with Germany. 

Data: The markets seem more sensitive to the flash PMI than to the current account figures that are also due. Recall that in September, the composite PMI stood at 51.2, its highest level since May 2024. It rose in the four months through September. It finished last year at 49.6. Ahead of the weekend, S&P downgraded France from AA- to A+, matching an earlier move by Fitch.  Moody's, the last of the big three rating agencies that ascribes a AA- equivalent to France (Aa3) will announce the results of its review on October 24. Separately, DBRS lifted Italy's rating to A (low) from BBB (high).  It is the highest rating from any major company.  Moody's rates Italy Baa3 (=BBB-) and has a positive outlook and will update it next month. 

Prices: The euro has been trending lower after recording a multi-year high near $1.1920 on September 17, when the Federal Reserve cut rates. It forged a bottom around $1.1540 and  reached almost $1.1730 before the weekend, the (50%) retracement of the losses since September 17. The euro stalled and found support around $1.1650. After the low was recorded, the euro was unable to reclaimed the $1.1680.  It settled near session lows.  Nearby support is seen in the $1.1630-40 area. The momentum indicators are turning over in over-sold territory. 

China

Drivers: Beijing remains committed to the yuan's shadowing of the dollar. In a weak dollar environment, the yuan typically loses ground against other currencies, and in a stronger US dollar environment, the yuan is among the better performers. Given the escalation of tensions between Washington and Beijing, there may be more speculation that the exchange rate could be weaponized. The US dollar did jump around the so-called "Liberation Day" in early April. It reached the year's high on April 8 near CNH7.43 (and ~CNY7.35). By the time the first tariff truce was announced (May 12), the dollar was around CNH7.20-CNH7.25. When the extension was announced on August 11, the dollar was about CNH7.18-CNH7.20. Yet, the PBOC set the dollar's reference rate a new low for the year last week. It was set at CNY7.0949 before the weekend, and CNY7.1048 at the end of the previous week. 

Data:  Owing to the close management of the exchange rate, the yuan does not appear particularly sensitive to Chinese data. In the week ahead, the most important report is the Q3 GDP and the real sector performance in September. The median forecast in Bloomberg's survey for Q3 GDP is 0.8% quarter-over-quarter after 1.1% growth in Q2. That would be the first sub-1% quarter since Q4 23. Year-over-year growth is seen near 4.7% (vs. 5.2%). If accurate, it would be the slowest pace since the end of 2022. It would likely spur speculation of more stimulus measures. The fourth plenum session of the Communist Party begins Monday. This is usually the forum to discuss the next five-year plan and announce personnel changes. 

Prices: The greenback briefly traded at a new low for the month, near CNH7.1170 before the weekend. It recovered and traded to CNH7.1325 to edge above the previous day's high. It settled within Thursday's range. It still looks broadly range bound. 

Japan

Drivers: The easy monetary and easy fiscal policy advocated by the new head of the LDP overwhelmed other drivers of the exchange rate. Still, the combination of MOF warnings about a one-sided rapid movement in the exchange rate coupled with the sharp drop in US yields amid the escalation of tensions with China effectively arrested the yen's sharp slide. The dollar has been correcting lower. On October 21, the Diet will pick a new prime minister. The opposition parties have failed to unite behind a single candidate, which means that the most likely scenario is for LDP's new leader Takaichi to be elected and become the first woman prime minister of Japan. 

Data: There are three data points that attract the market's interest in the week ahead, and while they pose headline risk, they are unlikely to overwhelm other considerations. The first is the September trade balance. The fact of the matter is that despite the yen being under-valued on nearly any metric, it experiences a trade deficit. This would seem to have implications for other currencies, such as the yuan, which are understood to be less undervalued than the yen. In the first eight months of the year, Japan reported a nearly JPY2.6 trillion trade deficit compared with a JPY4.7 trillion deficit in the same period last year, and JPY8.1 trillion in the Jan-Aug 2023. The second data point is the September CPI. Yet, we know from the Tokyo CPI that there will be little change in the headline and core measures, but that measure that excludes both fresh food and energy may converge with the headline and core rates. It stood at 3.3% in August, while the headline and core were at 2.7%. Third is the flash PMI. Typically, the local market does not put much weight on it. Still, for the record, the composite in September fell to 51.3 (from 52.0), the lowest since May. It finished last year at 50.5.

Prices: The dollar recorded a bearish key reversal on October 10 by making a new high for the move (~JPY153.25) and then sell-off to close (~JPY151.20) below the previous day's low. Follow-through selling took it slightly below JPY149.40 before the weekend. Yet, as US interest rates recovered, so did the greenback, which recorded new session highs in early North American turnover, slightly above JPY150.60. The recovery and strong close looks like bullish dollar price action. The greenback held above the key technical area marked by the gap that was created by the dollar's higher opening on October 6. The gap extends from the high on October 3 (~JPY147.80) to the October 6 low (~JPY149.05). Nearby resistance seen in the JPY151.00-40 area. 

UK

Drivers: Over the past 30 sessions, the correlation between changes in the euro and sterling is near 0.85, near highest since the year's peak in June, slightly above 0.92. The year's low was recorded in late July near 0.65. Sterling's inverse correlation with the Dollar Index is slightly higher around -0.88. Meanwhile, over the past 30 sessions, sterling's inverse correlation with changes in the US two-year (~-0.47) and its inverse correlation with changes in the UK's two-year yield have converged around (~-0.49). 

Data: The UK reports CPI, retail sales, and sees the preliminary October PMI. The bar to another cut this year (November 6 and December 8 BOE meetings) is high. A key reason is that inflation has accelerated to a 3.6% annualized rate in August compared with a 2.4% annualized rate in August 2024. However, the culprit is the rise in administered prices, which included energy, water, train fares, and an increase in local authority taxes. Consumers continue to shop. In volume terms, retail sales have risen by an average of 0.3% a month through August. They averaged a 0.5% increase in the first eight months of 2024, after contracting in Jan-August period of 2022 and 2023. Turning to the PMI, the composite flash a warning in September, falling sharply from 53.5, the best since August 2024 to 50.1, the weakest since April. The services PMI tumbled to 50.8 from 54.2, while the manufacturing PMI fell to 46.2 from 47.0. It has not been above the 50 boom/bust level since the end of Q3 24. 

Prices: Sterling recovered smartly from about $1.3250 on October 14, its lowest level since August 1. It reached $1.3470 before the weekend, a new high for the week. It stalled in front of the (50%) retracement of the decline since the September 17 high (~$1.3725), which is found slightly above $1.3485. Selling pressure pushed sterling to new session lows, and it took out the previous day's low near $1.3390. Nevertheless, it recovered to settle little changed near the middle of the day's range. What appears to be consolidation looks constructive. 

Canada

Drivers:  The Canadian dollar remains sensitive to the US dollar's overall direction, which may make sense given the relative size of the economies and integration. The low volatility of the exchange rate contributes to the Canadian dollar's better performance with the G10 in a strong US dollar environment. The Canadian dollar also sometimes is a risk-off currency, i.e., especially when US equities trend lower.

Data: The Bank of Canada's Q3 outlook survey on October 20 will likely confirm what the data have already suggested; namely, that economic activity is weak. Canada also reports August retail sales. Preliminary data from StatsCan suggest they recovered from the 0.8% decline in July. Yet the economy looks as if it stagnated in Q3 after contracting in Q2. Canada's CPI has risen at an annualized rate of 3.6% through August, the same pace as seen in the first eight months of 2024. The underlying core measures have accelerated this year. The central bank sees the underlying rate "in the vicinity of 2.5%."  Still, market has pared odds of a Bank of Canada rate cut this month and before the end of the year following the stronger than expected September jobs report.

Prices: The US dollar reached a six-month high last week near CAD1.4080. It spent the second half of last week consolidating mostly above CAD1.4020. The level yielded ahead of the weekend. The greenback posted an outside down day by trading on both sides of Thursday's range and settling below its low (~CAD1.4025). On a break of CAD1.40,  a push below the CAD1.3960 area would boost the chances a high is in place. The momentum indicators are over-extended and look poised to turn down. 

Australia

Drivers: We have been noting the sensitivity of the Australian's dollar exchange rate to changes in the US dollar broadly (proxy, the Dollar Index). However, this has changed dramatically. The rolling 30-day inverse correlation has slackened from -0.80 to around -0.27, the least since April 2022. There is an element of an increased role of risk-off as the correlation between changes in the exchange rate and changes in the S&P 500 (~0.74, the highest since January 2024). More difficult to quantify, but the escalation of tension between Australia's military alliances and its largest trading partner appears to also have weighed on the Australian dollar.

Data:  In a quiet week for Australian data, the preliminary October PMI is the highlight. The composite PMI fell to 52.4 in September (from 55.5 in August). Yet, the Q3 average of 53.9 is still the best quarter in more than three years. Australia is one of the few high-income countries with a manufacturing PMI above the 50 boom/bust. The futures market has almost a 60% chance of a cut at next month's central bank meeting. At the end of September, the futures market had less in 1-in-3 chance of a cut.

Prices: The Australian dollar recorded a key downside reversal after the FOMC's rate cut on September 17. It had set a new high for the year then near $0.6710. It has trended lower over the past month and tested the $0.6440 area last week. Ahead of the weekend, the Aussie settled firmly near session high near $0.6500.  The momentum indicators are oversold but have not turned higher. Meanwhile, the $0.6520 area must be overcome to stabilize the technical tone. 

Mexico

Drivers: In late September, the rolling 30-day correlation between changes in the USD-MXN exchange rate and the Dollar Index was near 0.83, the highest in more than a decade. It is now a little below 0.30, a five-month low. A risk-off element has strengthened. The inverse correlation between changes in the exchange rate and the S&P 500 is near -0.75. It has not been more sensitive since mid-2022. The exchange rate's sensitive to changes in the US two-year yield has been modestly positive for the past three months, but now is the most inverse since late May. 

Data: Mexico reports the August IGAE measure of economic activity, which is similar to a monthly GDP report. It has contracted in two of the three months through July. Mexico also reports August retail sales. They were flat in June-July. While the economy is generating faint economic impulses, price pressure remains elevated. Mexico reports CPI for the first half of October. Headline CPI in September stood at 3.76%, the highest since June. The core rate stood at 4.28%, the highest since April 2024. The official target is 3% in a 2%-4% range. Banxico has become more focused on the economic weakness, and the swaps market anticipates another quarter-point rate cut before the end of the year. 

Prices: With a brief exception on October 16, the US dollar spent last week within the range established on October 10: ~MXN18.3640-MXN18.6370. It test the low before the weekend. Last week's high was almost MXN18.63. Still, it settled below MXN18.50 without fail. In fact, outside of October 10, the greenback has not settled above MXN18.50 for over a month. Until a clearer macro picture emerges, broad sideways trading seems most likely. The greenback remains in its trough. It bottomed on September 17 near MXN18.20, a new low for the year. The dollar has not traded above MXN19.00 since late June. 

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