The coming week could see a shift from extending the USD’s recent rally to reassessing its sustainability. The greenback did not extend its gains last week, even after a stronger-than-expected US CPI inflation print. Fed officials downplayed the prospect of a rate hike at the October 27-28 FOMC meeting, leaving markets worried that policy has priced in an uninterrupted Fed-hiking cycle too aggressively. NZD and GBP performed relatively well, buoyed by more than 75% odds of a hike at their next central bank meetings – the Reserve Bank of New Zealand on October 28 and the Bank of England on November 5.
With the Fed entering its blackout period, investors may be reluctant to add to crowded long USD positions. The same inflation pressures that have supported the USD amid Fed-hike expectations are now feeding political risks into the US outlook. Opinion polls suggest that persistent cost-of-living strains could help the Democrats take control of both the House and Senate in the November 3 midterm elections, which would likely transform President Donald Trump’s remaining two years in office from advancing to defending his existing policies. A hostile Congress would constrain his legislative agenda, intensify congressional oversight, and increase the potential for fiscal confrontations.
However, the USD’s vulnerability does not translate automatically into EUR strength. Moody’s is due to review France’s sovereign debt rating, currently at Aa3 with a negative outlook, on October 23. The review is relevant because the European Central Bank has said that France could not use the Transmission Mechanism Instrument (TPI) to stabilize its bonds. Paris needs first to overcome its own political gridlock and set out a credible fiscal consolidation plan that removes it from the EU “excessive deficit procedure.” Although the US Treasury 10Y yield eased by 16.5 bps to 5.07% last week, the French 10Y yield fell by only 4.9 bps to 4.80% amid a 5.5 bps decline in the German 10Y yield.
GBP could offer a more attractive alternative to the EUR. Beyond a more favourable carry, GBP is supported by the IMF’s upgraded UK growth forecast and praise for taking steps to reduce debt and the deficit. Chancellor John Healey’s commitment to fiscal discipline ahead of the October 28 Autumn Budget has helped to contain concerns about a repeat of the 2022 mid-budget crisis. Markets will be watching for targeted cost-of-living relief that does not increase borrowing requirements or undermine the UK’s fiscal rules, as higher debt-servicing costs continue to squeeze the fiscal headroom.
Quote of the Day
“I don't know where the stock market is going, but I will say this, that if it continues higher, this will do more to stimulate the economy than anything we've been talking about today or anything anybody else was talking about.”
Alan Greenspan (Sworn in as Fed Chairman in the White House two months before Black Monday)
Today in history
Black Monday occurred on October 19, 1987. It remains the largest single-day percentage decline (22.6%) in the history of the Dow Jones Industrial Average.
Topic
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