Sunset Market Commentary

Markets

Yesterday’s ECB comments coming from Washington (IMF World Economic Outlook) almost exclusively sounded dovish. The disinflation process is running faster than hoped, downside growth risks might accelerate the process and even result in an inflation undershoot and more rate cuts towards neutral are coming. Central bankers didn’t push back against growing market odds of a 50 bps rate cut at the December meeting even if we still get two PMI surveys (starting tomorrow), two inflation readings, Q3 GDP data and Q3 wage numbers. Press agency Reuters this morning added to the debate. Citing sources close to discussions, they ran an article suggesting that ECB officials are starting to debate whether interest rates will need to be lowered to a level that stimulates economic activity i.e. below neutral (<2%). A small, but growing group of governors fears that the central bank fell behind the curve. They also want to drop the reference to restrictive rates in the policy statement to show that they are taking downside risks seriously. The current phrasing is: “the Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. It will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim.” German Bunds outperform US Treasuries on the growing divergence between ECB and Fed. The German yield curve bull steepens with front end yields sinking up to 7 bps. US yields add 1.8 bps (2-yr) to 3.7 bps (10-yr) as the focus remains on November 5th presidential elections and a Trump risk premium. The single currency succumbs to growing pressure with EUR/USD changing hands below 1.0778 support. A sustained break, eg in case of weak PMI’s tomorrow, opens the path to the April low at 1.0601. EUR/GBP did a second attempt to take out the 0.83 big figure, but seems to be waiting for the thumbs up by BoE governor Bailey who speaks in Washington as well tonight. The trade-weighted dollar adds to this month’s impressive rally with DXY rising to 104.50 for the first time since early August payrolls and following market-meltdown. Full retracement to the 106-106.50 is the most likely way forward from a technical point of view. JPY is obviously the biggest victim of higher US yields and the stronger dollar. USD/JPY today surges from 151 to 153, putting the Bank of Japan again in a difficult position with JPY weakness adding to the policy & inflation puzzle. USD/CAD tests the recent top around 1.3850 after the Bank of Canada accelerated its cutting cycle to a 50 bps move (4.25% to 3.75%) meant to boost growth and keep CPI close to 2%. More rate cuts are coming with data determining the pace. The BoC lowered its CPI outlook to 2.5%-2.2%-2% for the 2024-2026 policy horizon with the GDP outlook little changed at 1.2%-2.1%-2.3%.

News & Views

National Bank of Poland member Kotecki said that weaker retail sales (-5.7% M/M & -3% Y/Y in September vs -1% & +1.8% expected) data give hope for a somewhat faster decline in inflation, but at present the conditions for any policy modification are not yet met. Kotecki assessed the retail sales data as worrying, but wants further information to draw conclusions. At the same time he pointed out that headline inflation since July is again rising, admittedly due to temporary factors, and that the peak is still ahead of us. Core inflation also stopped declining, indicating that conditions are not in place to modify policy. He concluded that data point to moderate economic recovery but at the same time relatively persistent inflation. High wage growth remains a source of concern. Given the weak economy in Europe, Kotecki finds the 3.9% expected 2025 growth in the Polish budget as too optimistic. The zloty weakness substantially further today with EUR/PLN jumping from the 4.32 area to currently 4.345.

South African headline inflation printed at 0.1% M/M in September, slowing the headline figure to 3.8% from 4.4% in August, the lowest since March 2021 and dropping back below the mid-point of the South African Reserve Bank’s (SARB) 3%-6% target. The decline was supported by positive base effects compared to last year and transport inflation (-2.8% Y/Y). Food price inflation was 4.7% Y/Y, but the monthly rise (0.6%) was the fastest since January. Core inflation (ex-food and energy) was 0.3% M/M and 4.1% Y/Y (also 4.1% in August). The SARB cautiously cut its policy rate for a first time in September by 25 bps from 8.25% to 8%. Inflation data keep the door open for gradual follow-up cuts (next meeting on Nov 21). The rand, which had a good run between February and end September, is losing some further ground today, trading at USD/ZAR 17.7 (compared to a YTD low at 17.03 end September).