The market has much to digest. The Bank of England's new purchases of Gilts coincided with a reassessment of the trajectory of Fed policy. After the hawkish FOMC decision and forecasts, the market briefly thought the terminal rate could be 5.25-5.50% in the middle of next year. However, by the end of last week, it had returned to around 4.5% at the end of Q1 23. Italy has a right-wing government, and what it means for the country's debt and relationship with the EU are being debated. The cabinet will begin taking shape, and it could help shape investors' expectations. Italy's premium had jumped 30-40 since a little before the election.  

The rapid referendums in eastern Ukraine and Russia's annexation of the territories, after taking Crimea in 2014 point to a new phase in the conflict. Some observers are linking Russia's mobilization and rush for a referendum--even by its trumped-up standards, to the meeting with China's Xi rather than the setback of Russian forces at the hands of the Ukrainians armed to the teeth with US weapons and intelligence.  

Sometimes the narrative is about macro developments, but recently the price action itself has been the narrative. Central banks from several emerging markets are believed to have intervened to support their currencies, and Japan became the first G10 central bank to materially protest what the market was doing with the yen (still to be sorted out if it was about a level--less likely--than the one-way market--more likely). It looks like the initial estimates of a record JPY3.0 trillion (~$21 bln) was fairly close. BOJ figures suggest it was closer to the JPY2.85 trillion, which seems like a lot for a few nights of sound sleep. Still, the pullback in US yields helps protect the JPY145 level.  

Sterling's collapsed the new government's mini-budget spurred the Bank of England to comment. It was monitoring developments and would take the necessary measures to bring inflation down, and review both fiscal policy and sterling at its November 3 meeting. However, seeming to rule out an emergency meeting, which did not validate the sense of urgency seen by investors and businesses weighed on sterling. Yet, when systemic risks arose, the BOE stepped in. It announced a bond-buying program distinct from QE and it seemed to stop the panic. The Gilt market stabilized and sterling recovered to almost where it was before the government's fiscal initiative. The swaps market has a 150 bp hike at the next BOE meeting nearly fully discounted.

The price action in the debt markets is also the narrative.   The US 2-year yield has risen from almost 3.5% at the end of August to nearly 4.35%  in late September. It looks poised to re-test 4.0%. In early August, the US benchmark 10-year yield tested 2.50%. It poked above 4.0% last week before falling back below 3.70% before the weekend. The 10-year breakeven (the difference between the yield of the inflation-protected and conventional security) slipped below 2.10% before the weekend, its lowest since February 2021. The two-year breakeven slipped below 2% at the end of last week for the first time since late 2020.

The two-month rally in US equities indices has fully unwound. Europe's Stoxx 600 and the MSCI Asia Pacific Index also fell to new lows for the year last week. The general re-pricing of assets from a zero-interest rate environment to higher rates is a difficult process and it has become a moving target.  

Oil prices rallied almost 60% in the first half of the year and since mid-June, WTI has tumbled by nearly more than 35%, leaving it up less than 7% for the year. The US retail price for gasoline has risen over the last few days but did slip a little in September, its third consecutive monthly decline. At an average of around $3.80 a gallon, it has risen by slightly more than 15% since the end of last year. A broader measure of commodity prices, the CRB Index, has also pulled back since the mid-June peak. It has fallen by nearly 20%.  

There are a few data points next week that do stand out. First, is the US jobs report. The median forecast in Bloomberg's survey is for a 250k increase in non-farm payrolls, which includes an estimated 13k net loss of government jobs. The numbers have been so distorted by the shutdown and re-opening and shifting preferences that it may be difficult to know what is a normal number. In the four-year before the pandemic, the US averaged less than 200k additions a month. That means that the 250k median forecast (Bloomberg's survey), which would be the least since December 2020 will likely be seen as a robust figure by Fed officials.  

Of course, there are other dimensions that will be watched. These include the unemployment rate (which rose to 3.7% from 3.5%), the participation rate (increased to 62.4% from 62.1%, to match the highest since March 2020), and the average hourly earnings ( a 0.3% month-over-month increase will slow the year-over-year pace to 5.0% or slightly below). The JOLTS report on job openings appears seems to be attracting diminishing interest, even though Chair Powell still referred to it. Canada also reports September employment figures. It has lost full-time jobs for the three months through August.  

We would make the case for US auto sales being notable too. They are expected to have edged higher, and at 13.5 mln (SAAR) it would be the most since April. Although, through August auto sales are off about 15% year-over-year, a 13.5 mln unit pace September would be the second consecutive month of year-over-year improvement. In the current strong dollar environment trade figures are interesting, though the advanced goods balance report steals most of its thunder. Still, part of the issue is that the Fed does not meet until November 2, and the key for policy is not the real sector, provided the jobs report is broadly in line with expectations, is CPI (October 13).  

Japan's Tankan Survey (October 3) rarely moves the market, and this may be doubly true now as large business sentiment is better than for small businesses. Corporate profits are the highest in more than 50 years as the foreign earnings translate into more yen. Given the policy divergence, and the intervention to support the yen, Tokyo's September CPI will be watched as a good indicator of the national figures. Headline CPI may hold below 3%. The core rate (excludes fresh food) may have edged up from 2.6% in August. This could be the near-term peak, as the supplemental budget will offer new protection from energy and wheat prices and energy prices fall faster than the yen.  

The Reserve Bank of Australia and New Zealand meet. The market is slightly more confident that New Zealand's central bank will hike by 50 bp than Australia's. The RBA has hiked at every meeting since May for a total of 225 bp, bringing the target rate to 2.35%. It is clear that it is not done but it has signaled that after four half-point moves it could slow. Since it last met, the Australian dollar has fallen nearly 4.5% to two-and-a-half year lows near $0.6435. The RBNZ began its tightening cycle last October and has lifted the target rate by 275 bp to 3.0%. The swaps market has Australia's terminal rate between 4.25% and 4.50% in Q3 23. The terminal rate for the RBNZ is seen closer to 5.0%

Let's turn now to the foreign exchange price action. 

Dollar Index:  On September 20, the Dollar Index posted an outside up day by trading on both sides of the previous day's range and settling above its high. The rally that it signaled was completed in the middle of last week as DXY made new 20-year highs and then reversed lower and settled below the previous session's low. This key reversal saw follow-through selling to a new five-day low ahead of the weekend slightly above 111.55. That nearly met the (62.8%) retracement of the advance from September 20 (~111.45). Initial resistance is now near 112.80 and then 113.20. The MACD and Slow Stochastic are rolling over in over-extended territory. The 20-day moving average, the middle of the Bollinger Band is near 110.80.  

Euro:  The euro's recovery off the 20-year low set in the middle of last week (~$0.9535) stalled ahead of the weekend about three cents higher. Like the Dollar Index, it met the (61.8%) retracement objective of the move since September 20. It also stopped shy of the 20-day moving average (~$0.9890). Initial support is seen near $0.9700, and a break of $0.9650 would signal a return to the lows. The MACD firmed slightly last week but it has not established an uptrend. The Slow Stochastic has turned higher and it is still oversold. Parity is a key cap now. 

Japanese Yen:  The BOJ's intervention has helped steady the dollar-yen exchange rate. The market has been reluctant to push the dollar back above JPY145.00.   Since the middle of the week, the greenback has largely held above JPY144.00. The sideways movement has seen the MACD trend lower. The Slow Stochastic has also been trending lower but steadied last week. The pullback in US rates may be a contributing factor to the stability of the exchange rate. After briefly pushing above 4% in the middle of the week the 10-year US Treasury traded below 3.70% before the weekend. The two-year US yield reached almost 4.35% at the start of last week and finished below 4.18%.  

British Pound:  Sterling traded in a wide range last week. It began by extending the route after the new government's fiscal message and falling to its lowest level since the end of Bretton Woods, reaching $1.0350. The BOE's measures to address the threat to systemic stability helped spur a short-covering rally in sterling that lifted to a high at the end of the week of about $1.1235. Recall that it finished the previous week (September 23 near $1.0860 and traded almost to $1.1275 before the mini budget. The pre-weekend high met a technical retracement objective (~61.8% of the leg lower that began on September 13 from almost $1.1740). The momentum indicators have turned higher from oversold territory, and, of note, the Slow Stochastic is leaving a bullish divergence in its wake. While we think the market's response to the fiscal measures, which were largely what Prime Minister Truss had advocated during her campaign was exaggerated, the blow to sentiment was serious. Sterling needs to overcome resistance in the $1.1275-$1.1300 area to signal a deeper recovery, a loss of $1.09 could see $1.0750-$1.0800.  

Canadian Dollar:  Weak US stocks and an aggressive Federal Reserve kept the Canadian dollar on the defense last week. The greenback made a new two-and-a-half-year high near CAD1.3835 in the middle of the week. There was no follow-through USD selling after the key reversal on Wednesday. Support was found near CAD1.3600. The MACD is still rising but is stretched. The Slow Stochastic turned lower. The US dollar rose for its third consecutive week and seven of the nine weeks since the end of July. The Canadian dollar is no longer the best G10 performer this year against the US dollar. It lost top billing to the Swiss franc, which is almost 7% compared to the Loonie's 8% decline. More than half of this year's decline in the Canadian dollar took place in September (~-4.35%).  

Australian Dollar: As we saw with the Canadian dollar, so too with the Australian dollar:  The seemingly favorable price action in the middle of last week did not see follow-through action. Instead, weak consolidation was seen in the last two sessions. The Aussie slumped to a new two-year low near $0.6365 on September 28 and recovered to close a little bit above $0.6520. Before the weekend it traded to almost $0.6450. The MACD is at its lowest level since mid-May, and although it has not turned, it looks poised to do so in the coming days. The Slow Stochastic has curled up and from slightly above the low set earlier in September. Overcoming the $0.6575-$0.6600 area now would lift the tone. The futures market leans (~60%) in favor a of 50 bp hike by the RBA on October 4, essentially unchanged last week. A half-point move would lift the target rate to 2.85%. The terminal rate is seen a little over 4% near mid-2023. The RBNZ meets on October 5. The market is more confident that it hikes 50 bp and again in November, its last meeting year. That would put the target rate at 4%. The terminal rate is seen closer to 5.25% in early Q3 23.  

Mexican Peso:  As part of its broad rally, the US dollar pushed to MXN20.58 on September 28, its highest level in nearly two months. It reversed dramatically low and close that day near MXN20.1255. After the key reversal, there was no immediate follow-through selling, but ahead of the weekend, the greenback fell to new lows for the week around MXN20.09. The MACD is not clear, though the Slow Stochastic is curling lower. Last week, a few central European currencies gained against the dollar (Czech, Bulgaria, and Romania, but not Russia or Hungary), and after them was the peso. The peso's gain of about 0.5%  was enough to ensure a gain for the month, albeit small (less than 0.2%). We suspect there is potential now toward the lower end of the recent range (~MXN19.80).  

Chinese Yuan:  Before the weeklong holiday in China during the first week of October, officials drew the line in the sand. Reports suggested that it put banks on notice that they should be prepared for intervention. How do the banks prepare? Apparently, they cut their long dollar exposure. The dollar fell from CNY7.25 in the middle of last week to almost CNY7.0835 before the weekend. The greenback gapped lower last Thursday and Friday and both times the gap was quickly closed. The dollar settled near CNY7.1150, while against the offshore yuan the dollar finished a little below CNH7.1300. Given the sensitivity and official scrutiny, look for the dollar to trade within recent ranges against the offshore yuan during next week's holiday.  

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