A report by CYS Global Remit Strategic Sales Management Team
US FOMC in Focus | skip to SGD/CNY
The U.S. Department of Labor's Bureau of Labor Statistics (BLS) said in last Friday's closely watched jobs report that nonfarm payrolls increased by 199,000 jobs last month, much higher than the consensus estimate of 185,000. The strong job report, which further reinforces the US economy resilience narrative, is unlikely to dispel financial market expectations that the Fed is done with raising interest rates for the current cycle.
Last Wednesday, Treasury Secretary Yellen said market expectations could be a complement to the Fed's monetary policy if participants are thoughtful in interpreting upcoming data.
During a meeting with government officials in Mexico City, Yellen did not agree with traders' current expectations for the Federal Reserve to cut interest rates and declined to comment when asked whether bond markets were prematurely expecting a rate cut from the Fed. Market expectations for Fed decisions are part of the decision-making mix, she said.
We see the current U.S. economy as only moderately imbalanced. The condition for ending the tightening cycle is that all aspects of the economy reach equilibrium, such as the inflation rate reaching the 2% target. But beyond that, a self-reinforcing set of conditions is needed to keep inflation at 2%. This set of conditions includes nominal spending, wage growth, unemployment rate, etc.
The current tightening cycle in the United States began about two years ago and has gone through three main stages. Initially, markets expected a sharp tightening, followed by a sharp rise in interest rates and depressed asset prices. When the inflation rate falls, the market expects that the tightening will end soon, and interest rates will be cut accordingly.
This triggered a market rally and a sharply inverted yield curve. Later, it became clear that inflation was high, and the economy was strong enough not to warrant easing. This led to a second round of tightening, with long-term bond yields raising the gap with short-term rates narrowing, and markets moving downward again until the recent decline in inflation, the rebound in asset prices has roughly continued to this day.
The U.S. economic situation has not yet reached equilibrium, but it is close to the goal and moving in the right direction. At the same time, the economic slowdown and rising unemployment will push the situation closer to the goal. Inflation has fallen to the upper end of the acceptable range and real economic growth has stabilized near target. The labor market remains tight, hampering the pace of downward pressure on wages and inflation.
Job openings are shrinking, and wage gains are slowing slightly. Nominal spending has fallen from its peak but remains too high and has picked up recently. Taking all aspects into consideration, we believe that the U.S. economy is only moderately imbalanced, and the lagging effects of previous tightening may appear in the future.
For the world's major central banks such as the Fed, regardless of whether officials currently support interest rate cut expectations, the downward trend in Treasury yields is likely to ease financial conditions, thereby weakening the impact of the aggressive interest rate hike policies they have implemented.
The market's expectations for the end of the Fed's interest rate hike cycle and an interest rate cut in June next year can be said to challenge policymakers' statement that they will keep interest rates "higher for longer" in the foreseeable future.
All eyes will be on the FOMC meeting this week on December 12-13, which will be the Fed’s last meeting this year.
Our view is the Fed is done with its tightening cycle. We continue to hold the view that even if the Fed completes raising interest rates, it is unlikely that Fed officials will formally announce a halt to rate hikes. After all, the Fed has repeatedly surprised itself with the economy's resilience and is more willing to leave the door open to further rate hikes.
With the Fed at the end of its tightening cycle, we are beginning to see the moderate-to-soft USD profile playing out, as the FX market is forward-looking. We still think that for the market to fully support that narrative, we need to see Fed officials introduce “rate cuts” in their interest rate policy languages – which is not expected to happen until the first half of 2024. For now, we expect emerging currencies to start recovery against the greenback, with the higher-for-longer narrative fading in favor of a dovish Fed pivot.
China’s services sector pickup
China's service industry recovered more than expected in November.1 China’s Caixin services PMI in November was 51.5, up 1.1 percentage points from October, exceeding the expected value of 50.5, the highest in the past three months.
Sub-item data show that the expansion rate of supply and demand in the service industry has accelerated slightly, but the overall situation is still weak. In November, the service industry operating index and new orders index both rebounded slightly to the highest level in the past three months but were still lower than the long-term average.
Affected by various adverse factors, internal and external demand is still insufficient.
Employment pressure is still high, and the foundation for economic recovery needs to be further consolidated. Looking into the future, policies still need to focus on expanding consumption, increasing income, promoting employment, and stabilizing expectations.
Considering that the economic growth in the third quarter slightly exceeded expectations and the low base effect in the fourth quarter, the full-year economic growth target is within sight. Policy measures that focus on the long term and consolidate the foundation for long-term economic growth should be strengthened to continue to cultivate the long-term confidence of market entities.
Price increases for labor and raw materials have slowed down, and combined demand has been sluggish. In November, the service industry input price index fell within the expansion range, hitting a new low since July 2022 for two consecutive months. As cost pressures eased, sales price growth in the service industry also slowed. Market confidence in the service industry has increased slightly. The services industry business expectations index rose slightly in November from the previous month's low but is still below the long-term average.
The market should be prepared for further RMB appreciation and more short squeezes are expected, especially if driven by seasonal factors. Starting from 2017, November to January are the traditional months for foreign exchange settlement. The RMB has appreciated significantly. But over time, the marginal effect will gradually weaken. In particular, the current interest rate gap between China and the United States is still wide, and the sharp short-term rebound of the RMB may attract carry traders to enter the market, that is, go long the USD again to earn more interest rate differentials. Therefore, subsequent changes in the Fed's monetary policy remain crucial.
We believe that the USD index is the pricing anchor for the central parity of the RMB. We also note that the USD index is greatly affected by the strength of European currencies. If the euro turns softer, the USD will "passively strengthen". In the short term, the RMB exchange rate is expected to enter a two-way fluctuation range at the 7.1 mark.
In terms of interest rate differentials between China and the United States, after rapidly trading in expectations of the end of the Fed’s interest rate hike cycle and US economic cooling, the short-term downward trend in U.S. bond yields will slow down marginally.
We have always maintained our take that improvement in economic fundamentals is crucial to revive investors’ risk-on sentiments, and encourage foreign fund flows back into the world’s second-largest economy. For now, a weaker USD (due to softer US CPI prints) contributed to the continued strengthening of the RMB. A further decline toward the psychological key 7 level before year-end remains on the cards. The recent RMB exchange rate has returned to the appreciation channel, mainly due to the continuous decline of the USD index and changes in market expectations.
At present, the market has judged that the U.S. interest rate hike cycle is over and will choose a looser policy to support the U.S. economy. The USD index has continued to fall, and the yields on 10-year treasury bonds in China and the U.S. interest rate spreads continue to narrow. Additionally, year-end is typically the seasonal peak of foreign exchange settlement. As the demand for RMB exchange settlement increases, the RMB exchange rate is expected to rebound strongly.
Looking forward, as the unilateral strong trend of the USD index against non-U.S. currencies comes to an end, and with strong support from the steady recovery of domestic economic fundamentals, the RMB exchange rate will gradually rise back to a reasonable price range consistent with the currency value.