Risk of 50 bp cut by the Fed tomorrow keeps the greenback on the defensive

Overview: With heightened expectations of a 50 bp cut by the Federal Reserve tomorrow, the dollar has not gotten a reprieve and is softer against nearly all the currencies. Japan's long holiday weekend ended, and the greenback has held above JPY140 today. It is consolidating, but against most of the G10 currencies, the dollar's losses have been extended. The Canadian dollar is the other exception amid speculation that the Bank of Canada can accelerate the pace of its cuts barring a surprise with today's August CPI report. Emerging market currencies but a few, including the Mexican peso, are a little softer. 

Equities are mostly firmer, though Japanese stocks fell as the market re-opened from last Friday and saw the yen's relative strength. Most other markets, including Hong Kong and the index of mainland companies that trade there, advanced. Europe's Stoxx 600 snapped a three-day advance, but is back on the winning side today, up a little more than 0.5% in late morning turnover. US index futures are also trading higher. Bond markets have advanced, and benchmark 10-year yields are at new lows in many European countries and the US. European yields are off 1-3 bp and the 10-year US Treasury is nearly a basis point lower at 3.61%. Gold set a record-high yesterday slightly below $2590 and is consolidating lower today. It is hovering near $2575 late in the European morning. Support is seen by the pre-weekend low around $2557. November WTI is consolidating at the upper end of yesterday's range, when it set a seven-day high near $69.60. It is around $68.70. Yesterday's low was by $67.70. 

Asia Pacific

Chinese and South Korean markets remain closed while Japanese markets reopened after the long holiday weekend. No doubt, Japanese investors and policymakers understood overseas markets took the dollar below JPY140 for the first time since July 2023. We continue to believe that the decline in US yields is the biggest drag on the exchange rate, and the adept picking a top in US rates was the key to the apparent effectiveness of intervention this year (and 2022). One needs not to revisit the traditional skepticism in the literature about intervention to account for this. Japan reports August trade figures tomorrow. Although the yen remains undervalued by most metrics, Japan continues to run a trade deficit, though it has been halved from a year ago. Through July, the average monthly deficit this year was JPY553 bln. In the first seven months of 2023, it averaged a little more than JPY1 trillion a month. The highlight of the week is likely to be a hawkish hold by the BOJ at the end of the week. That is to say, it will most likely stand pat and reiterate that it intends to raise rates further provided the economy continues to evolve as expected. Australia's calendar is light until Thursday's employment report. The central bank meets next week. A hawkish hold is likely here too, as the central bank is still not satisfied that the inflation genie is back in the bottle. 

The dollar stabilized against the yen after falling to slightly through JPY139.60 yesterday in the Asia Pacific yesterday when Japanese, Chinese, and several other local markets were closed for holiday. The low in North America was near JPY139.75 and the briefly traded higher on the day as European markets were closing near JPY140.90. There are around $4 bln in options that expire tomorrow in the JPY142.55-60. Even with a rise in US rates in response to what is expected to be firm underlying retail sales and a recovery in industrial output, we suspect the dollar will not get that high and could be capped in the JPY141.50-60 area. So far today, the dollar has held above JPY140 and saw a high in of almost JPY141.25 early in the Asia Pacific session but has spent mostly between around JPY140.50 and JPY140.80. The Australian dollar reached almost $0.6770 today, a couple hundredths of a cent above the high set September 6 (US jobs day). With yesterday's gains, the Aussie met the (61.8%) retracement objective of the slide since the seven-month high was set on August 29 (~$0.6825). Nearby resistance is in the $0.6775-85 area and support is now seen around $0.6725-35. The greenback is consolidating quietly inside yesterday's range against the offshore yuan. Yesterday the session low was reached early in European turnover yesterday near CNH7.0880. It recovered to CNH7.10 but has not been much above CNH7.1020 today. Mainland markets re-open tomorrow. The dollar settled near CNY7.0970 before the weekend. It had finished last week around CNH7.10. 

Europe

Germany's September ZEW survey did not tell us anything new. Germany is again "the sick man in Europe," and sentiment reflects this. The assessment of current conditions fell to -84.5 from -77.3 and is at its lowest level since May 2020, when Covid was among its most intense. The expectations component had risen from August 2023 through June 2024 when it hit a wall. It reached 47.5 in June, its best level since July 2021. It now stands at 3.6, the lowest since last October. Still, the eurozone is not the focus this week. The euro ticked lower on the headline news but quickly recovered. The UK reports August CPI tomorrow and the BOE meets Thursday. Norway's central bank also meets on Thursday. Neither central bank is expected to cut rates, but after the British economy unexpectedly stalling in June and July, if there were to be a surprise this week, it would seem to be the BOE. 

The euro traded through the down trendline drawn off the highs set in late August (~$1.12) and on September 6 (US employment report day high ~$1.1155) that came in near $1.1125 yesterday. It settled back below it after stalling in front of $1.1140 (large option expiry at $1.1145 yesterday). It is trading firmly today and is near $1.1145 in European turnover. A close above the trendline would have bullish implications if  the downtrend is a pennant pattern. The measuring objective would be near $1.14. Sterling held a similar trendline yesterday that came in around $1.3220, but it has taken it out today to reach $1.3230. Unlike the euro, it settled above the (61.8%) retracement of the decline from last month's high. Sterling set a two-year high late August near $1.3265, and the September 6 high was almost $1.3240. Initial support may be near $1.32. 

America

It is a busy day for US data, ahead of the conclusion of the FOMC meeting on Wednesday. Softer auto sales and lower gasoline prices likely weighed on headline retail sales after the 1% jump in July. Core retail sales likely fared better. Still, consumption appears to have slowed in Q3 after a 2.9% (quarter-over-quarter annualized rate) in Q2. Industrial production and manufacturing output are expected to have recovered part of the ground lost in July (-0.6% and -0.3% for industrial production and manufacturing output, respectively). July business inventories are also due. The 1.2% increase in Q2 was the most inventory accumulation in a quarter since Q3 22. The question is whether the inventory build is desired or not. We suspect both are in play. Some of the inventory accumulation ahead of may be purposeful ahead of what may still be a US dockworkers strike, the threat and now actual Boeing strike, elevated Middle East tensions, and the risk of volatile weather. Some of the inventory accumulation, like in autos, may not be fully desirable. Canada reports August CPI today. A flat reading, which is the median forecast in Bloomberg's survey, would translate to a 1.2% three-month annualized rate. The year-over-year rate would fall to 2.1% from 2.5%. The underlying core measures will also likely soften. The swaps market is pricing in 73 bp of cuts before the end of the year. There are two meetings left, so this reflects strong expectations of a 25 bp and a 50 bp cut.

The Canadian dollar has not moved much in recent days. Last Tuesday, the US dollar traded between roughly CAD1.3555 and CAD1.3615. With one exception around last Wednesday's US CPI, this range remains intact. In the past four sessions, a shelf has been carved near CAD1.3565. There are options for $1 bln expiring today at CAD1.3650, which seem too far. The Canadian dollar does not seem particularly sensitive to political developments in recent weeks that have weakened Prime Minister Trudeau. The NDP withdrew support and Trudeau's Liberals lost its second special election yesterday (a district in Montreal) after a defeat in a Toronto district in June. The US dollar tumbled almost 4.75% against the Mexican peso from Wednesday's high to Friday's low last week. It made a marginal new low yesterday, slightly below MXN19.16, but recovered in the North American morning to almost MXN19.39 before it consolidated mostly between MXN19.22 and MXN19.32. It is trading quietly today between about MXN19.21 and MXN19.28. The MXN19.5350 area marks the first retracement objective of the slide in the second half of last week. As the peso pulled back, the Brazilian real rose to new high for the month. The US dollar briefly traded below BRL5.50. The central bank's weekly survey showed economists raised their interest rate projection for the end of next year to 10.50% from 10.25%. The rate for the end of this year remained at 11.25%. The Selic rate is currently sits at 10.50% and is widely expected to be hiked to 10.75% tomorrow. A convincing break of BRL5.50 could spur a move to the lower end of the three-month trading range around BRL5.40.