Key Factors Influencing Asian Currencies During Fed Rate Cuts

Outlook for Asian Currencies

Risks and Uncertainties on the Horizon

Source: Euronews

In the absence of any major data or events in Australia this week, markets continued to ponder the likely timing and shape of the RBA’s easing cycle, eventually pricing in only about two and a half 25bp interest rate cuts by the end of 2025. These developments mirrored the modest changes in global sentiment, but the centre of the debate being on the question of ‘when’ locally versus ‘how fast’ and ‘how much’ interest rates are going to go down globally is a clear point of distinction.

Next week’s Q3 CPI update will prove critical in calibrating local market expectations. Our preview delves into the detail behind our expectations and forecasts for the forthcoming update. In summary, the full roll-out of cost-of-living rebates across the states are set to drive headline inflation back into the target band in Q3 – we forecast 2.9%yr. The RBA will instead be more focused on trimmed mean inflation, to the extent that it will provide a clearer gauge of the true underlying momentum of inflation. We anticipate a constructive development on this front too, with trimmed mean inflation forecast to ease from 3.9%yr in June to 3.5%yr in September.

Should the headline results and general composition from the data print broadly as we expect, we view the inflation dynamics as being most consistent with a February start to the rate cutting cycle. At a pace of 25bps per quarter, we anticipate the cash rate to reach a terminal rate of 3.35% by the end of next year. This end-point is predicated on our view that the global structure of interest rates will be higher than it was pre-pandemic. In this week’s essay, Chief Economist Luci Ellis discusses why reversion to pre-pandemic ‘norms’ might not necessarily be an appropriate baseline.

Late last week, China’s Q3 GDP data came in weak at 4.6%yr, well below the official government’s target. Monthly data for September showed some signs of activity picking up. Industrial production rose 5.4%yr supported by strong growth in chips and EV production. News on consumer spending was also positive, as retail sales accelerated to 3.2%yr, the highest since May, with the government subsidies for consumer goods providing a boost. Meanwhile, property investment and sales continue to decline in the double digits. Looking ahead, the Q4 data will be closely watched for impacts of the stimulus measures announced since late September, with a lift expected to provide the support needed for the economy to reach target growth.

In advanced economies, politics dominated the news flow. Opinion polls in the US suggested that Donald Trump was gaining momentum, with financial markets pricing USD and government bond yields higher. Political uncertainty also increased in Japan, as polls show that the ruling coalition led by the new Prime Minister Ishiba might struggle to secure a majority. This will be a huge departure from the norm as the Liberal Democratic Party has been in power most years since 1955, mostly recently having lost power in 2009. And in the UK, the focus remained on next week’s Budget announcement by the new Labour government, with news reports highlighting the significant challenges for public finances ahead.

Against that backdrop, the global PMIs for October showed that growth momentum in most major economies weakened at the start of Q4. In the euro area, the composite index remained in contractionary territory for a second month, and was down by 0.6pts from the Q3 average. The composite PMI in the UK fell to 51.7, the lowest level for nearly a year, and was consistent with quarterly UK GDP growth of only 0.1%qtr, which represents a sharp slowdown from the first half of this year. Meanwhile, the US PMIs stood out, implying firmer and more stable growth momentum despite the uncertainty ahead of the election. Indeed, the US composite PMI came in at 54.3, slightly higher compared to September levels, and unchanged from the Q3 average. But the FOMC’s Beige Book was more sanguine suggesting that the US economic activity was little changed from its July update. Negative impact from hurricanes to agriculture, tourism and the general business activity in the Southeast was noted, but employment was assessed to have increased slightly. Wage growth was described as modest, and most districts saw slight increases in selling prices.

South of the border, the Bank of Canada accelerated the pace of easing and lowered the target for the overnight rate by 50bp to 3.75%. In its communications, it highlighted that inflation returned to the 2% target falling significantly in the last few months, but lower interest rates are needed to maintain it at that level, in particular given concerns about the weakness in the underlying growth momentum.

Malaysia's leading index (LI) continued to demonstrate strong growth momentum in August, with a growth of 4% to 114.3 points from 109.9 points in the same month of the previous year, said the Department of Statistics Malaysia (DOSM).

Chief statistician Datuk Seri Dr Mohd Uzir Mahidin said the growth reflects improvements across all components of the index.

“Looking at the smoothed long-term trend in August, the LI consistently exceeded 100.0 points, indicating that the Malaysian economy is growing steadily, bolstered by strong economic fundamentals and a positive outlook for external trade,” he said in a statement on Friday. 

The DOSM on Friday released the Malaysian Economic Indicators: Leading, Coincident and Lagging Indices for August 2024. The LI provides an early indication of significant turning points in the business cycle and the economy’s direction in the near term.

However, Mohd Uzir noted that on a monthly basis, the LI declined by 0.7%, down from 115.1 points in July, due to significant reductions in real imports of semiconductors (0.8%), expected sales value in manufacturing (0.6%) and Bursa Malaysia's industrial index (0.3%).

Meanwhile, he said the coincidence index (CI), which reflects the current economic situation, recorded an annual growth of 2.1% in August, reaching 126.5 points against 123.9 points in the same month of the previous year.

“This increase was largely driven by growth in most components, except for real salaries and wages in manufacturing, which saw a slight decline of 0.3%,” he said.

For monthly performance, Mohd Uzir said the CI showed a marginal decrease of 0.6%, affected by downturns in four out of six components, notably in real contributions to the Employees Provident Fund (0.3%).

Source: The edge markets

Source: Reuters

Even hawkish ECB members seem in favour of significant easing

The wedge between US and EUR rates continues to widen. While in absolute rate levels there are signs that investors are seeing the levels as oversold, the case for US rates to underperform on a relative basis is easier to make. Against a backdrop of a likely Donald Trump win, if the polls are to be believed, the data continues to surprise. This time it was an unexpected decline in jobless claims alongside slightly better S&P PMIs.

On the EUR side, one could argue that a prospective Trump administration will have negative repercussions on the eurozone's economic outlook – Lagarde has even flagged it. The data itself, as seen in the latest PMIs, does not paint a picture as gloomy as the sudden dovish push by European Central Bank officials suggests. But again, we heard from ECB officials that policy rates should no longer be restrictive once the inflation target of 2% is sustainably met. Paired with earlier sources, the next projections by the ECB could see inflation at the target level in the first half of next year. Thus, the market has reason enough to price growing chances of a 50bp cut in December and a terminal rate below 2%.  

Gilt investors likely to remain nervous until budget plans are final

Going against the prevailing tide, Gilts saw quite a sell-off, seemingly triggered by increasing unease about upcoming budget plans. Speculation is that Chancellor Reeves is preparing to free an additional £50bn by changing the key debt metric underlying the UK’s fiscal rules. Such a cosmetic adjustment would enable more infrastructure investments without the need for stringent tax increases. Funding this would require more Gilt issuance, pushing yields up.

Perhaps more important for rates was the recalibration of the Bank of England's terminal rate, which markets see landing higher on the back of more government expenditure. The 1-month swap rate 2 years forward increased by some 4bp to around 3.7%. We still think this is high, and given Bailey’s more dovish tone this week, the priced-in terminal rate could still come down. Having said that, markets will probably want to await the official budget announcement on Wednesday before making the move lower.

We may also have a modest risk premium as the government's fiscal discipline comes under closer examination again. Investors have not forgotten about the short-lived UK Prime Minister, Liz Truss, when she presented an unfunded budget and Gilt yields soared. For the moment, such a situation seems averted, and markets appear confident that Reeves will remain broadly committed to budget rules. 

Friday’s events and market view

Today, the German Ifo should attract some attention. If it echoes the slight improvement we saw in the German PMI then it would be somewhat at odds with the ECB’s sudden sense of alarm.. We'll get other data on money supply and the ECB’s consumer inflation expectations survey. The ECB’s Villeroy will speak later in the evening. In the US, we will get the durable goods orders as well as the final University of Michigan consumer sentiment index.

One highlight for government bond markets will come only after markets close. Moody’s is slated to review the French Aa2/Stable rating and S&P is scheduled to review Belgium’s AA/Stable. For both, there is some downside risk, clearly for France, since Moody’s assessment is still one notch above where S&P and Fitch rate the country, the latter of the two only recently having assigned a negative outlook. Markets, however, appear to have already baked in a healthy dose of pessimism and spreads over Bunds have trended tighter since October.

Primary markets see Italy issuing short-dated and inflation-linked bonds for up to €5bn.