The forex markets are consolidating after experiencing robust volatility, especially for sterling, as a hard Brexit is in the cards. Yields in the U.S. have been moving higher making the pound less attractive but, it now appears that European yields are playing catch up.
The 10-year Gilt benchmark yield lifted by more than 12 basis points at the intraday peak over 1.22%, the loftiest level seen since just before the Brexit vote on June 24. Gilts had until recently been considered a Brexit safe haven, though the extent of sterling losses has brought both inflation risk and portfolio pressure on foreign holders of Gilts.
At the same time some of the more recent U.S. data points have slightly reduced the chance that the Fed will pull the trigger on higher rates in December. During the thirdweek of October, futures are pointing to a 60% chance of a Fed rate hike down from the 70% change priced into the futures market during the second week of October.
Recent manufacturing data has taken the edge off of U.S. yields. U.S. industrial production rose 0.1% in September with capacity at 75.4%. The 0.4% drop in August production was revised lower to -0.5%, with July’s 0.6% gain bumped down to 0.5%. August capacity use was nudged down to a 75.3% rate versus 75.5% previously. Manufacturing production bounced 0.2% versus -0.5% which was revised from -0.4%, with auto and part production rising 0.1% from 0.9% which was revised up from 0.5%. Machinery production slid another 0.6% from -2.3% which was revised form -1.9%. Computer and electronic production was unchanged after the prior 0.7% gain which was revised from 1.0%. Utilities dropped 1.0% from -0.3% which was revised from -1.4%. Mining increased 0.4% from -1.0%.
While Industrial production is a rearview mirror data point, recent October expectations have also declined. For example, the US Empire State manufacturing index fell 4.8 points to -6.8 in October after improving 2.2 points to -1.99 in September. The employment component improved slightly to -4.7 from -14.29, with the workweek at -10.4 from -11.61. New orders were -5.6 from -7.45. Prices paid rose to 22.6 from 16.96, with prices received at 4.7 from 1.79. The 6-month business conditions index edged up to 35.8 from 34.53 The future employment index was 9.4 from 7.14, with new orders at 39.0 from 31.89, prices paid at 35.8 from 41.07, and capital expenditures at 13.2 from 10.71.
Despite the weaker than expected data, there are many on the Fed that continue to believe the Fed will need to raise rates in December and possibly multiple times in 2017. The Boston Fed’s President Eric Rosengren says “he expects unemployment to fall to 4.7 percent and inflation to beat the Fed’s 2% target, leaving policymakers at risk of having to squelch the recovery with faster-than-expected rate increases.” The forex markets have priced in 1-tightening, and with inflation expectations remaining relatively low, it is hard to see the dollar continuing to move higher without stronger economic data.
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