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Downside Risks Rising for USD as Inflation Fails to Lift

16 October 2017FX

USD: Downside risks rising as US inflation fails to lift

  • According to Citi analysts, the seventh consecutive below consensus US core CPI at +0.1% month-over-month versus +0.2% month-over-month expected for September with core goods prices declining +0.2%, the weakest reading since March 2017 and reinforced by falling US inflation expectations in the University of Michigan Sentiment Survey for October (the one-year measure down from 2.7% to 2.4% and down one-tenth to 2.3% for 5-10Yrs) appears to pose a serious challenge to the prospect for a Fed rate hike in December.
  • As a result, USD sentiment appears increasingly vulnerable given markets are now discounting an almost 80% chance of a Fed hike in December. According to Citi analysts, coupled with waning optimism regarding tax reform as talk of a compromise builds and as the Republican majority in the Senate appears to be at risk given McCain and Corker's lack of support for the president, further downside in USD appears likely for now.

GBP & EUR: EUR resilience supported by a possible October announcement on cutting bond purchases; Pounds (GBP) capped on Brexit concerns

  • Press reports Friday suggest the ECB may be considering cutting QE to EU30bn a month from January and extending quantitative easing (QE) until Sep18. Such a move would be seen as a more aggressive culling of QE than earlier expected and bullish for EUR. Citi analysts see risks for an even more hawkish scenario than Friday's press reports suggest with the ECB likely to buy €150-200bn in bonds over 6 months with the risk of an even smaller outcome of €180bn spread over 9 months.
  • Pounds (GBP)'s attention now turns to this week's 19-20 October EU Summit in Brussels. Most important for the UK is the EU27 meeting on Brexit. Citi analysts think the EU will neither end the talks nor move beyond phase one and expect a middle outcome: EU negotiator Barnier may draft a negotiating directive for transition talks by offering the UK a two-year transition stay in the EU market if the UK agreed to settle its financial obligations with the EU and sign a divorce agreement.

Commodity Bloc: AUD defies gravity, NZD awaits NZ election resolution, CAD to focus on BoC Wilkins's comments this week

  • AUD gains against USD on Friday are primarily a result of the weakness in the latter but its gains on crosses are more difficult to explain especially coming against the backdrop of a dovish RBA Financial Stability Report where the Bank remains concerned that relatively high interest rates could leave highly indebted households strapped to service debt or spend.
  • NZD on the other hand, remains hostage to the NZ election outcome with a decision likely this week. NZDUSD manages to eke out some gains against USD (largely on the back of USD weakness) though a broad based rebound may only be possible upon a resolution of the election deadlock and a stronger NZ Q3 CPI on the 17th (Citi analysts expect a pick up to 0.4% quarter-over-quarter versus flat in Q2).
  • CAD awaits the BoC rates decision on October 25th and all eyes will be on Senior deputy governor Wilkins' Q&A this Tuesday for signs of a possible third interest rate hike. The BoC has indicated that future hikes would depend upon (1) how incoming data (i.e. growth, labor market, sentiment) influence the inflation outlook, and (2) the sensitively of the economy to higher interest rates. Note that Citi analysts still maintain the BoC may raise rates at the upcoming meeting despite market pricing that attaches virtually no chance of an October hike.

CNY: China's trade data supportive of a more two-way flow in CNY

  • China's export growth rebounds, recovering to 8.1%YoY from 5.6%YoY in August, though still worse than market expectations. Imports also speed up markedly from 13.5% year-over-year in last month to 18.7% year-over-year and the monthly trade balance narrows sharply from $41.9bn in August to $28.5bn in September, the lowest reading since March this year. The data is not supportive of a strong RMB, and the currency is likely to show more 2-way fluctuations against the USD in Q4 as a result.

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