Gilts Are Go With 'Do Nothing' BoE Policy

Economic

Bond

Summary:

If the Bank of England is indeed done hiking rates, it calls time on a dire couple of years for British government bonds - even as the central bank offloads more of its gilt stockpile.

Bruised and battered bond bulls now look to Britain for hope of some redemption in yet another year of losses across sovereign debt markets - not least as they absorb a fresh hit to U.S. Treasuries after the Federal Reserve this week signalled one more hike was in store and upped its growth forecasts.

But preempted by news of a surprise drop in UK inflation last month and the likelihood of further disinflation over the coming months, a split BoE policymaking council on Thursday halted - at least temporarily - its relentless two-year crunch.

It's been enough to prompt many banks to say peak UK rates are now finally in at 5.25% after more than 500 basis points of increases - a cycle that BlackRock points out is three times the size of any squeeze since the BoE took sole charge of rate setting in 1997.

To be sure, Britain has been an inflation outlier to date in the post-pandemic price surge. It has struggled more than most with the Russia-seeded energy shock and gilts suffered severe credibility damage in the aborted budget giveaway one year ago.

But with its underlying economy weaker and more prone to the imminent mortgage rate resets than its peers, UK bonds may at last be priced better than other G7 debt for the road ahead.

"From a total return perspective within the sovereign space, 10-year gilts are probably the most attractive bond market," said Oliver Eichmann, portfolio manager at giant German asset manager DWS, even as he cautioned that a second wave of global inflation was still obviously a risk for all bond markets.

Many funds have already been jockeying for position.

From a 15-year peak of 4.75% just a month ago, 10-year nominal gilt yields have dropped almost 50 basis points already, falling below U.S. and Australian equivalents for the first time since March. Two-year gilt yields have plunged almost a full percentage point since July and, at 4.85%, are now below U.S. and Canadian counterparts.

And yet despite the recent rebound, catchall exchange traded funds in gilts are still down more than twice U.S. and European peers for the year to date, and investors still see value in UK bonds.

"Gilts look at attractive levels with the BoE on hold," said Franklin Templeton's David Zahn, adding FT was now positioned "long duration" in its gilt fund and had added currency-hedged gilts to its European fixed income accounts.

While BlackRock strategist Vivek Paul described the UK economic outlook as "bleak", he added: "The positive news is that UK asset pricing does reflect much of this story, which makes UK gilts and equity attractive relative to U.S. peers."

Candriam fund manager Jamie Niven also fancies UK rates over global peers, with "the market underestimating the current level of restrictiveness." Gilts Are Go With 'Do Nothing' BoE Policy_1

Gilts Are Go With 'Do Nothing' BoE Policy_1

Do Nothing

And therein lies the rub for many investors.

What UBS economist Paul Donovan dubs the "doing nothing" policy - otherwise known as "higher for longer" - automatically lifts the real cost of credit in economies going forward as income growth subsides.

UK wage growth remains brisk - but the situation is compounded in Britain as refinancing in the now dominant UK fixed-rate mortgage market comes quicker than in the United States or euro zone as most are still just for two to five years in length.

"Without hiking rates again, the impact of rate hikes will continue to ramp up," said ING's James Smith, adding that the length of time rates stay high is much more important than how high they go in the short term.

Smith pointed out that the average rate on existing UK mortgage lending has gone from roughly 2% to 3% already but as more people refinance those heads to 4% by next spring and probably 4.5% by the end of next year.

"Ultimately the UK economy can't sustain rates above 5% indefinitely and we think something closer to 3% is a more likely medium-term level," he said.

And hence while the UK may not have been the first major central bank to hit peak rates - the European Central Bank likely beat it to that last week even if the U.S. Federal Reserve still feints at one more hike - the BoE may well be the first to cut next year despite it's "higher for longer" spiel.

What could possibly go wrong for gilts?

A second-wave inflation spike - which is worrying given the recent backup in energy prices - is clearly a risk for all bond markets and policymakers. And a renewed plunge in sterling could compound that effect on dollar-demominated energy and commodity import prices.

A year on from the 2022 budget farce, fiscal policy is always a concern. But Finance Minister Jeremy Hunt on Wednesday stuck to his tighter budget stance by insisting tax cuts this year were "virtually impossible".

The BoE's decision to cut its stockpile of bonds by 100 billion pounds ($122.91 billion) over the next 12 months - via both sales and allowing bonds to mature - was higher than the 80 billion pounds reduction over the past year and may rankle.

Like the Fed and the ECB, the BoE will be keen for bond markets not to loosen prematurely before inflation falls further.

But Thursday's balance sheet had been well flagged by the BoE in advance and it claimed this summer that extensive market liaison suggests the additional amount can be absorbed without disruption.

For some, this nudge on long-term liquidity merely reinforces the chance that the BoE is now done on policy rates.

And so, long the laggard, gilts may well be back in vogue. Gilts Are Go With 'Do Nothing' BoE Policy_4

Gilts Are Go With 'Do Nothing' BoE Policy_5

Gilts Are Go With 'Do Nothing' BoE Policy_6

($1 = 0.8136 pounds)

Source: Reuters

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FXOpen

Economic

Forex

The Pound Sterling (GBP) finds offers while attempting to extend recovery as investors see no change in the current policy divergence between the Federal Reserve and the Bank of England (BoE). The GBP/USD pair looks set to test its six-month low as BoE policymakers have shifted their focus to safeguarding the economy from recession risks.

The UK economy has been through a vulnerable phase as the BoE was consistently raising interest rates so that inflationary pressure above the desired rate could recede. While the BoE still cannot announce a victory over inflation as it is more than three times the desired rate, the UK's economic outlook has worsened as firms are operating on lower capacity and labor growth has slowed.

Daily Digest Market Movers: Pound Sterling remains weak amid risk-off mood

Pound Sterling faces selling pressure after a pullback move to near the round-level resistance of 1.2300 as investors expect Fed-BoE policy divergence to become sustained.
The BoE paused its lengthy policy tightening cycle on Thursday as policymakers shifted their focus to recession risks propelled by worsening economic prospects caused by higher interest rates.
UK central bank held interest rates steady after raising them 15 times straight since December 2021 to ensure price stability.
A pause in the rate-tightening spell is going to provide relief to households that were facing trouble in augmenting their installment obligations due to higher interest rates.
The BoE maintained the status quo after Governor Andrew Bailey, policymakers Broadbent, Dhingra, Pill, and Ramsden voted to hold, while Cunliffe, Greene, Haskel, and Mann wanted to lift the key rate to 5.5%.
However, the BoE kept room open for further policy tightening if inflationary pressure remains persistent.
This week, UK inflation for August remained soft despite rising energy prices. Monthly headline inflation expanded at a slower pace of 0.3%, while investors anticipated it accelerating at a pace of 0.7%. In July, the economic data contracted by 0.4%.
On annual terms, the headline CPI softened to 6.7% vs. July's reading of 6.8%. The core CPI that excludes volatile food and oil prices softened significantly to 6.2% against the estimates of 6.8% and the 6.9% figure recorded in July.
After UK inflation data, Chancellor Jeremy Hunt said the soft inflation report indicates that "the plan to deal with inflation is working – plain and simple." He further added that inflation would be halved to 5.3% by year-end if the authorities stick to their plan.
BoE policymakers warned that interest rates will remain lofty "long enough" to bring down inflation to target.
About the economic outlook, the BoE conveyed that Q3 Gross Domestic Product (GDP) now is expected to rise 0.1% (Aug: +0.4%), with underlying growth in H2 2023 likely weaker than forecast in August.
Meanwhile, the UK's Office for National Statistics (ONS) has reported slightly weaker Retail Sales for August. On a monthly basis, consumer spending rose by 0.4% vs. expectations of 0.5%. In July, Retail Sales contracted by 1.1%. While the economic data excluding fuel prices matched expectations at 0.6%.
The market mood remains cautious as the Federal Reserve stressed keeping interest rates sufficiently high for a longer time to ensure price stability.
The U.S. Dollar Index (DXY) consolidates near a six-month high around 105.70 ahead of the preliminary S&P Global Manufacturing PMI for September, which will be published at 13:45 GMT.
Despite a pause in the rate-tightening spell by the Fed, the U.S. Dollar is expected to remain resilient as the U.S. economy has absorbed the consequences of higher interest rates in a better manner than other G7 economies.

Technical Analysis: Pound Sterling faces pressure near 1.2300

Pound Sterling finds sellers after a short-lived pullback move close to 1.2300. The Cable is only marginally above the six-month low around 1.2200. The asset has stabilized below all short-to-long-term daily Exponential Moving Averages (EMAs). Momentum oscillators support further weakness in the Cable.

Pound Sterling FAQs

What is the Pound Sterling?

The Pound Sterling (GBP) is the oldest currency in the world (886 AD) and the official currency of the United Kingdom. It is the fourth most traded unit for foreign exchange (FX) in the world, accounting for 12% of all transactions, averaging $630 billion a day, according to 2022 data.Its key trading pairs are GBP/USD, aka 'Cable', which accounts for 11% of FX, GBP/JPY, or the 'Dragon' as it is known by traders (3%), and EUR/GBP (2%). The Pound Sterling is issued by the Bank of England (BoE).

How do the decisions of the Bank of England impact on the Pound Sterling?

The single most important factor influencing the value of the Pound Sterling is monetary policy decided by the Bank of England. The BoE bases its decisions on whether it has achieved its primary goal of "price stability" – a steady inflation rate of around 2%. Its primary tool for achieving this is the adjustment of interest rates.

When inflation is too high, the BoE will try to rein it in by raising interest rates, making it more expensive for people and businesses to access credit. This is generally positive for GBP, as higher interest rates make the UK a more attractive place for global investors to park their money.When inflation falls too low it is a sign economic growth is slowing. In this scenario, the BoE will consider lowering interest rates to cheapen credit so businesses will borrow more to invest in growth-generating projects.

How does economic data influence the value of the Pound?

Data releases gauge the health of the economy and can impact the value of the Pound Sterling. Indicators such as GDP, Manufacturing and Services PMIs, and employment can all influence the direction of the GBP.

A strong economy is good for Sterling. Not only does it attract more foreign investment but it may encourage the BoE to put up interest rates, which will directly strengthen GBP. Otherwise, if economic data is weak, the Pound Sterling is likely to fall.

How does the Trade Balance impact the Pound?

Another significant data release for the Pound Sterling is the Trade Balance. This indicator measures the difference between what a country earns from its exports and what it spends on imports over a given period.

If a country produces highly sought-after exports, its currency will benefit purely from the extra demand created from foreign buyers seeking to purchase these goods. Therefore, a positive net Trade Balance strengthens a currency and vice versa for a negative balance.

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Cohen

Economic

Central Bank

The Swiss National Bank (SNB) and the Bank of England (BoE) surprised by maintaining their rates unchanged at yesterday's trading session. The Bank of Japan (BoJ) surprised by maintaining its ultra-lose monetary policy stance unchanged. Combined with a hawkish pause earlier this week, the major currencies further sank against the greenback. The USD/CHF advanced past the 200-DMA, and Cable slipped to 1.2232, a fresh low since March, and whispers of a potential return to parity against the US dollar sparked, yet again. Reasonably, the pound-dollar could return to 1.20, and below, if the major 38.2% Fibonacci support – which stands at 1.2080 is pulled out and lets the pair slip into a medium-term bearish consolidation zone. But we will likely see the Federal Reserve (Fed) soften its tone before we start talking about parity in Cable.

Now, looking at what the BoE did, you know that I was surprised, and intrigued with the decision. In Switzerland for example, inflation – official inflation – steadied below the SNB's 2%, target. The latest data shows that the Swiss CPI is at no higher than 1.6% – even though we are expecting a monstrous rise in health insurance costs, and another 20% rise in average in electricity costs that will certainly drill holes in our pockets at the start of next year, but for now inflation is at 1.6%, say the numbers, and alone, it justifies a SNB pause. But in Britain, the no action is quite premature. Inflation in Britain is almost at 7%, the energy prices are rising, the war in Ukraine is nowhere close to being over, sterling pound is now losing value, which means that whatever the Brits will import from now will cost them more than during the last months, when the pound was appreciating. It's hard to see how, with all these developments, the BoE won't be obliged to hike, again. The only way is a really bad economic performance.

A bright spot

If there is one bright spot in Britain with all this, it is the FTSE100. First, the rising energy prices are good for the energy-rich FTSE100. Second, softer sterling makes these companies more affordable for international investors, who should of course think of hedging their sterling exposure, and third, more than 80% of the FTSE100 companies' revenues come from oversees, which means that when they convert their shiny dollar revenues back to a morose sterling, well, they can't really complain with a stronger dollar. Consequently, if a more dovish BoE is bad for sterling, the combination of a hawkish Fed and a dovish BoE and a pitiless OPEC is certainly good for the FTSE100. The index has been left behind the S&P500 this year, as the tech rally is what propelled the American index to the skies, but that technology wind is now turning direction. The FTSE 100 broke its February to September down trending trend to the upside and is fundamentally and technically poised to gain further positive traction, whereas, the S&P500 is heaving a rough month, with technology stocks set for their worse performance this year, under the pressure of rising US yields, which make their valuations look even more expensive.

Interestingly, the US 2-year yield peaked at 5.20% after the Fed's hawkish pause this week and is back headed toward the 5% mark, but the gap between the US 2-year yield and the top range of the Fed funds rate is around 40bp, which is a big gap, and even if the Fed decided not to hike rates, this gap should narrow, in theory. If it does not, it means that bond traders are betting against the Fed's hawkishness and think that the melting savings, the loosening jobs market, tightening bank lending conditions and strikes, and restart of student loan repayments and a potential government shutdown could prevent that last rate hike to happen before this year ends. And indeed, activity on Fed funds futures gives more than 70% chance for a third pause at the FOMC's November meeting, and Goldman Sachs now sees the US expansion slow to 1.3% from 3.1% printed in the Q3. KPMG also warned that a prolonged auto stoppage may precipitate contraction. And if no deal is inked by noon today, the strikes will get worse.

One's bad fortune is another's good fortune

The Japanese auto exports surged big this year, they were 50% higher in yen terms. The yen is certainly not doing well, but yes, you can't have it all. That cheap yen is one of the reasons why the Japanese export so well outside their country. And in case you missed, the BoJ did nothing today to exit their hyper-ultra-loose monetary policy. They didn't even give a hint of normalization, meaning that the yen will hardly strengthen from the actual levels. In the meantime, Toyota, Mitsubishi and Honda shares are having a stellar year, and the U.S. strikes will only help them do better.

Source: Swissquote Bank SA

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Samantha Luan

Economic

Central Bank

Forex

In a move that left many market observers bemused, Yen declined in Asian trading session after BoJ opted for continuity, leaving its monetary policy untouched. Notably, the bank refrained from dropping any hints about potential alterations in its policy stance in the foreseeable future. With U.S. 10-year yield surging to a remarkable 16-year high, Yen may face further selling pressure in the coming sessions. Meanwhile, attention is shifting to forthcoming PMI releases from major economies, including Eurozone, UK, and U.S., as the week approaches its end.

Reflecting on the week's performance, both Sterling and Swiss Franc have been the laggards, affected by decisions of BoE and SNB to maintain their policies unchanged. The anticipation is growing that these central banks might have reached the apex of their tightening cycles already. Trailing closely behind in terms of weakness is Yen. New Zealand Dollar has emerged as the top performer, followed by Canadian Dollar and U.S. Dollar. Euro and Australian Dollar are exhibiting a mixed performance.

Technically, in light of Fed's hawkish stance this week, market players are keenly watching for signs of escalating risk aversion. If DOW plunges below 34092.22 support level and wraps up the week beneath it, it would not only signify a renewed decline from 15679.13 but also set a bearish tone that extends into Q4, potentially aiming for 31429.82 support. Yen Down on Silent BoJ; DOW Stares at Key Support in Week's Finale_1

Yen Down on Silent BoJ; DOW Stares at Key Support in Week's Finale_1

In Asia, at the time of writing, Nikkei is down -0.43%. Hong Kong HSI is up 0.86%. China Shanghai SSE is up 0.67%. Singapore Strait Times is up 0.05%. Japan 10-year JGB yield is down -0.0037 at 0.750. Overnight, DOW dropped -1.08%. S&P 500 dropped -1.64%. NASDAQ dropped -1.82%. 10-year yield surged 0.131 to 4.480.

BoJ stands pat, drops no hint on future adjustment

BoJ maintains a steady course today and keeps monetary policy unchanged. It also chooses choosing not to make any adjustments in the statement that would suggest a departure from its existing negative interest rate stance or the yield curve control measures. The central bank even retains the pledge that it "will not hesitate to take additional easing measures if necessary."

In unanimous decisions, short-term policy interest rate is held at -0.10%. 10-year JGB yield target is held at 0%, with a band of plus and minus 0.5%. Moreover, the bank's offer to purchase 10-year JGBs at a rate of 1.0% daily through fixed-rate market operations remains unchanged.

BoJ anticipates the Japanese economy to maintain a moderate recovery in the near term. However, it has also flagged concerns, noting that the economy is "under downward pressure stemming from a slowdown in the pace of recovery in overseas economies." Beyond this phase, the central bank is optimistic that the economy will exhibit growth "at a pace above its potential growth rate" due to the strengthening of a "virtuous cycle from income to spending."

Regarding inflation, BoJ foresees the year-on-year core CPI to "decelerate" owing to diminishing import price effects. Nevertheless, in the subsequent period, the CPI is projected to "accelerate again moderately", spurred by an improving output gap, along with rising medium-to-long-term inflation expectations and wage growth.

Released earlier, Japan headline CPI slowed slightly from 3.3% yoy to 3.2% yoy in August. CPI core (ex-food) was unchanged at 3.1% yoy. CPI core-core (ex food and energy) was unchanged at 4.3% yoy.

Japan's PMI manufacturing fell to 48.6, slackening demand and lower employment

Japan's Manufacturing PMI further declined from 49.6 to 48.6 in September, falling short of the anticipated 49.9, marking the most pronounced contraction since February. PMI Services also receded from 54.3 to 53.3. PMI Composite, which gives a holistic view of the broader economy, tapered off from 52.6 to 51.8.

Usamah Bhatti, an Economist at S&P Global Market Intelligence, noted that the future doesn't seem particularly rosy, with forward-looking indicators hinting at a possible slackening of demand and activity. While service firms did experience a rise, manufacturing segment reported a sharp decline in new orders, the most pronounced in seven months.

Another worrisome development is the reduced employment levels in the private sector. Bhatti stated, "As pressure on capacity eased, there was a renewed reduction in employment levels." This trend was "the first since the start of the year and the quickest since August 2020." He attributed this to companies not replacing those who voluntarily exited, often as a strategy "amid elevated cost burdens."

Australia PMI composite back to expansion, risk of "no land" for the economy

In September, Australia's Manufacturing PMI slipped to a 3-month low, declining from 49.6 to 48.2. In contrast, PMI Services showcased resilience, rising from 47.8 to a 4-month high of 50.5. PMI Composite also surged from 48.0 to 50.2, a 4-month peak, signaling a return to expansion in the broader economy.

Warren Hogan, Chief Economic Advisor at Judo Bank,said that "demand in the economy is holding up, and business activity remains on a sound footing." He further remarked that, contrary to some expectations, the present economic scenario isn't about choosing between a "hard or soft landing." Instead, he proposed that the real risk is of "no landing" for the economy.

Hogan further touched upon the inflation concerns that have been a pivotal discussion in financial circles. "The inflation indicators remain elevated at levels pointing to above-target CPI over the next 6-9 months," he stated. He pointed out that input prices remained unchanged in September, hinting at continued cost pressures. However, the final prices index experienced a slight dip in the September flash report. Despite this marginal decline, Hogan suggested that "inflation over the second half of 2023 could be higher than desired."

This latest PMI data follows a trend of stronger-than-predicted figures emerging from Australia in recent weeks. While this demonstrates economic stamina and persisting inflation, all eyes are on RBA's next steps. Hogan postulates that the RBA Board, under leadership of the new Governor Michele Bullock, will likely adopt a patient stance. However, he doesn't rule out further monetary tightening, possibly "in early November on Melbourne Cup day," should the economic indicators not align with RBA's projections of a slowdown.

New Zealand's trade data sees China dominates decline in exports and imports

In August, New Zealand observed a dip in both its goods exports and imports compared to the previous year, leading to a monthly trade deficit of NZD -2.3B.

Compared to figures from August 2022, goods exports saw a reduction of NZD -296m, marking a -5.6% yoy drop, settling at NZD 5.0B. On the other hand, goods imports displayed an even steeper decline, shrinking by NZD -639m or -8.1% yoy, amounting to NZD 7.3B.

A deeper dive into the export figures revealed China as the major contributor to the monthly dip. Exports to China fell sharply by NZD -262m, representing an -18% yoy decline. Other notable declines were witnessed in exports to Australia, which dipped by NZD -71m (-9.0% yoy), and Japan, with a decrease of NZD -34m (-11% yoy). However, there was some silver lining with U.S. and EU. Exports to the USA grew by NZD 62m, marking a 9.6% yoy increase, and those to the EU surged by NZD 28m, a 7.7% yoy rise.

China also took the lead in the contraction in imports. Imports from China plummeted by NZD -363m, a stark -19% yoy decline. Other significant reductions in imports were observed from Australia, down by NZD -92m (-9.7% yoy), South Korea with a drop of NZD -74m (-13% yoy), and U.S. decreasing by NZD -36m (-5.4% yoy). In contrast, imports from EU displayed a robust growth, climbing by NZD 120m or 12% yoy.

ECB's Lane: 4% deposit rate can bring inflation back to target within projection horizon

ECB's Chief Economist, Philip Lane, offered insights into last week's rate hike during a speech overnight. He noted that "the choice between holding at 375 and moving to 400 was finely balanced," referring to the deposit rate. Lane went on to express that opting for an additional hike was a safer decision "at a margin".

He believed that 4% deposit rate should be "consistent with a return of inflation to target within the projection horizon." The condition is that it's to be " maintained for a sufficiently long duration".

Looking to the future, Lane cautioned about the extended phase of uncertainty that looms regarding the disinflation process. Highlighting the intricacies of the present economic climate, Lane pointed to the "initial inflation shock, the lagged nature of wage adjustment in the euro area, [and] the considerable sectoral rebalancing" as contributors to the prolonged period of inflation uncertainty.

Looking ahead

UK retail sales and PMIs will be featured in European session together with Eurozone PMIs. Later in the day, Canada will release retail sales while U.S. will publish PMIs too.

USD/JPY Daily Outlook

USD/JPY dipped to 147.31 but quickly recovered. Intraday bias is turned neutral first. For now, further rally is in favor as long as 147.00 support holds. Above 148.45 will resume larger rally from 127.20. Next target is 151.93 high. However, firm break of 147.00 will should confirm short term topping, and turn bias to the downside for 145.88 support and below. Yen Down on Silent BoJ; DOW Stares at Key Support in Week's Finale_2

Yen Down on Silent BoJ; DOW Stares at Key Support in Week's Finale_2

In the bigger picture, while rise from 127.20 is strong, it could still be seen as the second leg of the corrective pattern from 151.93 (2022 high). Rejection by 151.93, followed by break of 137.22 support will indicate that the third leg of the pattern has started. However, sustained break of 151.93 will confirm resumption of long term up trend. Yen Down on Silent BoJ; DOW Stares at Key Support in Week's Finale_3

Yen Down on Silent BoJ; DOW Stares at Key Support in Week's Finale_3

Source: ActionForex

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SAXO

Economic

Bond

Stocks

Forex

Commodity

Market Data

U.S. Equities

Rising Treasury yields, which reached new highs since 2007, continued to weigh on stocks. The S&P 500 plunged 1.6% to 4,330, marking a decrease of more than 1.5% in a single day for the first time since April. All sectors declined, with the rate-sensitive real estate sector being hit the hardest. Magacap Tech names dragged down the Nasdaq 100, which tumbled 1.8% to 14,694. Amazon plummeted 4.4%, while Nvidia declined by 2.9%.

Fixed income

Yields from the belly (5-year) onward to the long end extended their post-FOMC march higher following the surge in long-end UK Gilts after the Bank of England held rates unchanged across the pond and a surprise drop in the initial jobless claims to 201K, signifying a still-hot U.S. labor market. The USD15 billion 10-year TIPS action registered robust demand. Selling concentrated on the long end, with the 10-year and 30-year yields rising by 9bps to 4.49% and 13bps to 4.57%, respectively, while the 2-year yield ended the session 3bps lower at 5.14%.

China/HK Equities

Following the post-FOMC selloff in the U.S. equity market, the Hang Seng Index slid by 1.3% to 17,655, while the Hang Seng Tech Index plunged by 1.9%. Healthcare, materials, and information technology were the top laggards. Alibaba Health tumbled by 4.9%, and XPeng plummeted for the second day, down by 6.9%, after lowering the selling price of the new version of its G9 model. The CSI300 shed 0.9%.

FX

Dollar strength continued in the post-Fed reaction, although some of the gains were reversed. High event risk from the Bank of Japan meeting ahead and USD/JPY hit fresh near 11-month highs of 148.46 but fell subsequently to ~147-.50 levels. AUD/USD plummeted from highs of 0.6511 to drop back towards 0.64 amid risk-off although NZD/USD did better and stayed above 0.59 on Q2 GDP surprise. GBP/USD broke below key 1.23 support with BOE holding rates but rebounded to the big figure later. EUR/USD stays below 1.07.

Commodities

Crude oil prices remained soft earlier in the session on Fed's higher-for-longer message offsetting concerns of tighter supplies, but Russia's announcement to temporarily ban diesel and gasoline exports brought some gains again. Macro theme continued to be of a risk-off, which is capping the move in oil towards $100 for now. Copper was down over 2% along with declines in other base metals amid risk-off and lack of China stimulus announcements.

Macro

US jobless claims fell to 201k from 221k, the lowest since the end of January, and against expectations for a rise to 225k. The downtrend again suggested that labor market is not cooling too rapid, and raised concerns whether the Fed will have to keep its foot on the pedal.
The Bank of England defied market expectations and kept interest rates unchanged with a 5-4 vote split. Instead, the Bank upscaled the rate of quantitative tightening from £80b to £100b per annum to accommodate a larger bond maturity profile next year. A tightening bias was maintained with the MPC repeating the message that "further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures". Market still expects another rate hike with 70% probability.
Among other central bank meetings yesterday, the Swiss National Bank defied wide expectations for a 25bps hike and left its policy rate unchanged, while Sweden and Norway's central banks both hiked the expected 25bps. Brazil's central bank cut rates by the expected 50bps after starting the easing cycle in August and following recent rate cuts by Poland and Chile.
Japan's headline August CPI came in firmer-than-expected at 3.2% YoY vs. expected 3.0%, slowing only a notch from prior 3.3% YoY. Inflation ex-fresh food remained unchanged at 3.1% YoY, and also above expectations while the core-core measure (ex-fresh food and energy) held up at 4.3% YoY as expected.

In the news

The China Securities Regulatory Commission (CSRC) has checked with several major brokers about short-selling activities and trading strategies of their quant clients (Reuters)
Cisco to Buy Splunk for $28 Billion in Giant AI-Powered Data Bet (Bloomberg)
To reduce AI costs, Google wants to ditch Broadcom as its TPU server chip supplier (The Information)
Microsoft announced a "unified" AI for its Windows 11 platform and four new Surface devices (Reuters)
Senate Republicans are predicting that Speaker Kevin McCarthy (R-Calif.) will need to reach out to House Democrats to get the votes to prevent a government shutdown at the end of next week (The Hill)

Macro events

BoJ Policy Announcement – read full preview here
EZ/UK/U.S. Flash PMIs (Sep), UK Retail Sales (Aug), Canadian Retail Sales (Jul)

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FXCM

Central Bank

Economic

The Bank of Japan maintained its uber-loose stance, which includes interest rates at -0.1%, yield curve control (YCC) and quantitative and qualitative easing (QQE). It also reaffirmed its dovish outlook, saying it will "patiently continue with monetary easing" and will not hesitate to take additional action if necessary, in order to achieve the 2% inflation target "in a sustainable and stable manner".

Earlier today, CPI ex-fresh food steadied at 3.1% y/y in August and although it has moderated from the recent four-decades peak, it has been printing above the central bank's 2% target for seventeen straight months. The BoJ itself over the summer raised the median inflation projection, to +2.5% for FY2023, from +1.8% previously.

Having been troubled by decades of deflation, policymakers struggle to create a virtuous price-wage cycle, which makes them hesitant to call it a day. They believe that "sustainable and stable achievement" of the 2% target "has not yet come in sight", requiring the continuation of monetary easing.

Back in July the central bank took a step towards normalization by loosening its grip on the yield curve control, but that change also allows it to sustain its dovish stance. Earlier this month, Governor Ueda opened the door to an eventual exit from negative rates, saying that officials could have enough data to make that determination by the end of the year. This marked a hawkish shift in rhetoric, but no imminent action was indicated.

The BoJ's loose monetary setting places it on the opposite side of it major counterparts, especially the U.S. Fed, which has been a great source of strength for USD/JPY. The Fed delivered a hawkish hold on Wednesday, keeping another hike on the table and pointing to a tighter 2024 policy path than previously expected. The latest round of decisions sustains the favorable monetary policy differential.

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Samantha Luan

Economic

Stocks

Energy

Contrarian investors were rewarded for betting on the beaten down U.S. energy sector earlier this year with a blazing rally. Some believe a tight oil market and resilient U.S. growth will keep energy stocks rising for the rest of 2023.

The largest U.S. energy exchange traded fund, the Energy Select Sector SPDR Fund, is up nearly 15% over the last three months and stands near its highest level in nine years.

The move follows a rally in oil that has taken the price of U.S. West Texas Intermediate crude (WTI) up more than 30% since June on supply concerns from extended production cuts by Saudi Arabia and Russia, as well as unexpected strength in the U.S. economy.

Bullish investors argue that energy stocks are still cheap by historical standards - and far less richly valued than other areas of the market. The energy sector currently trades at a forward price to earnings ratio of 12.2, well below its historical median forward P/E of 15.3, according to LSEG DataStream. The S&P 500 trades at a forward P/E of 20.

"Valuations can go up even if the oil price stays static because on a cash flow basis these stocks are very reasonably priced," said Charles Lemonades, head of hedge fund Value Works LLC, who is overweight the sector.

Energy stocks surged last year as inflation jumped to 40-year highs but landed with a thud at the start of 2023, when expectations of a U.S. recession and oversupply encouraged investors to take profits.

Both forecasts failed to materialize: economic growth in the U.S. proved far more resilient than many had predicted, despite the Federal Reserve's most aggressive monetary policy tightening in decades.

Meanwhile, drillers have been taking rigs offline, contributing to what is widely seen as a tight market, while Russia and Saudi Arabia have curtailed production.

The U.S. rig count is about 16% below where it was this time last year, according to data from U.S. energy services firm Baker Hughes. Overall, U.S. oil output from top shale-producing regions is on track to fall for a third month in a row in October to the lowest level since May, the U.S. Energy Information Administration said.

Despite recent gains, the S&P 500 energy sector is up only 4.2% year-to-date, compared with a 38% rise in technology stocks and a nearly 45% rise in communication. The broader S&P 500 index is up about 16%.

"Energy companies have newfound supply discipline" that will keep oil supply constrained, wrote Savita Subramanian, equity and quant strategist at BofA Global Investors, who has an overweight on the sector.

Citi on Monday became one the latest banks to predict that global benchmark Brent crude could exceed $100 a barrel this year.

While higher oil prices tend to eventually weigh on demand, that is unlikely to happen until Brent rises to between $110 and $120, said Bjarne Schieldrop, chief commodity analyst at SEB Research.

At the same time, continued production caps by Russia and Saudi Arabia will keep a floor under oil prices for the time being, he said.

Parts of the market appear skeptical energy stocks have much further to run.

Bearish investors point to the sector's earnings, where growth rates are expected to decline by 37% in the third quarter, followed by double-digit declines in both the fourth quarter and the first quarter of 2024, according to LSEG estimates. Sizzling Rally in U.S. Energy Stocks Has Room to Run, Bulls Say_1

Sizzling Rally in U.S. Energy Stocks Has Room to Run, Bulls Say_1

Energy demand could suffer if a rebound in the economy of top commodity consumer China fails to materialize. A 2024 recession in the U.S. - which many strategists still view as a possibility despite growing hopes of a soft landing, could also weigh on oil prices.

Persistently high oil prices could also lead to worries over a rebound in U.S. inflation, bolstering the case for the Fed to cool economic growth by keeping rates higher for longer.

"A supply driven increase in oil prices brings the prospect of both a renewal in inflation … and a slowdown in real consumer expenditures," analysts at Macquarie wrote.

Still, Rodney Clayton, a portfolio manager at Duff & Phelps Investment Management, believes the energy sector's large dividends will attract income-seeking investors - especially if the economy falters and bond yields fall.

"Companies are building up the trust of investors and are very reluctant to cut those dividends," he said. "That should result in a ... smoother ride for energy stocks than we've been accustomed to."