The Week Ahead - Blow Up?

Maybe a bloma. Maybe a bloma. We have to make that decision. We bloma, make a deal with the time it's coming. It's going to end very soon one way or the other. Hello and welcome to the week ahead on the Muripotcasts. My name is Dominic Bunning, head of G10 FX strategy here at the Murin London and today is Friday the 2nd of October. Well you're joining us at the end of a pretty wild week in financial markets. We had some comments there from President Trump talking about potentially blowing up his adversaries in Iran, but the real blow-up we saw in markets was in government bonds where we had some particularly violent moves in French government bond yields relative to German bond yields, so that spread wide and out significantly, peaking at just over 150 basis points on Friday. A lot of that has really been driven more by technicals, but the underlying fundamentals clearly in France remain a struggle, and we'll talk about that a little bit with Josie Anderson, our European economist later in the podcast. We'll also talk a little bit about what that might mean for the ECB as well as the recent inflation numbers in Europe. Bring it more up to date. We also just had about an hour and a half ago, as I record this, the U.S. labor market data, which was a little bit weak on the headline numbers and saw the dollar sell off slightly, but actually when you look at the detail it does seem to be a bit more resilient. We're going to talk about that with Russia Sharma, and also why we're pretty confident in our view that the Fed will not hike in October, but still has one more rate rise left in December. Finally in Asia, we're going to be focusing a bit more detail on India where we have the RBI decision next week, and also talk about some of the structural vulnerabilities in the economy. But before we get into all of that, I just want to flag a very special edition of the Weekhead Podcast, which we recorded earlier this week at our London macro forum with Dr. Catherine Mann of the Bank of England, where we talk through what's been happening to financial conditions and how she thinks the Bank of England should respond to recent developments. So please do find the link and check out that special edition. That said, let's get stuck in to this weekhead. Well, let's start in the US this week. It's payrolls Friday, and we're recording this just over an hour after the labor market release came out. I've got Russia Sharma with me, our US economist, Russia. Thanks a lot for joining us in a busy day for you. What are your first thoughts on the US live market, guys? So broadly speaking, I think labor market is still resilient. So just looking at the headlines, we saw that payroll gains surprised to the downside as compared to our unconscious expectations, but the three month average is still at 51k. If you look at Fed's estimate of the breakeven employment, we're still well above that. Interestingly, there seems to be a new trend emerging in labor market. So the composition of job gains is changing. We've seen that employment has expanded consistently in cyclical sectors and that's being actually led by construction and manufacturing. So it seems like that data center construction activity that seems to be having a positive spillover effects. Looking at other details, we think that while the overall impact of AI on job market that remains limited, there are a couple of things micro data suggests that it's it's begun to affect some narrow sectors or employment in information sector, for example. But again, overall broadly labor market looks positive. Household survey was actually pretty positive. The measure of employment rose for a second consecutive month there. Though the unemployment rate ticked up, we saw that the rise was mainly due to labor force dynamics rather than layoffs or lack of hiring. Essentially the job finding rate rose in September to its highest level in over a year while measures of layoffs they remain mixed. So underlying trend that remains subdued. So still strong positive, strong labor market and that should keep the Fed focused on inflation risks. Yeah, I mean, when I, where I'm sad, it looks like a pretty good number when you look at the detail and actually like you say, there's no sign that the late market is a worry for the Fed or even the reason for them to try to just kind of doing okay and doing fine in the background. But the inflation day, obviously, has been more of a concern. But on that front, we did guess some slightly better numbers in the week in the PCE. Was that kind of a really improvement? Or is it more just the changes in methodology? Yes, we got the annual revisions and we saw that core PC inflation that was actually revised sharply. It now stands at around 3% in July from 3.34% previously. As you said, most of the downward revision that came from methodological changes. So the BA undertook this exercise and one of the most noisy components portfolio management and investment advice prices they were actually revised down. The other components their revisions were actually in line with what we were expecting. So I think overall just from a policy perspective, this looks like a positive surprise, a nice development on the inflation front. So if you look at the September PCE forecast, so this has undershot that. If you look at comments from various policy makers, this seems to be a positive development. And even looking at, you know, Varsha's diffusion index measures, they also showed a modest improvement. So overall, I think this is likely to be welcomed by the Fed. So we are now forecasting that, you know, core PCE inflation ends the year at 3%. This is still well above the Fed's target. But again, this is undershooting the Fed's forecast that it penciled in the September SAP. Yeah. And you mentioned some policy makers comments that briefly, I think we heard from both Williams and Jefferson in the last sort of few days. They did seem to sort of pour a little bit of cold water on the idea that Fed could go back to back. The market seems to have taken that onboard as well as the data. That's something you guys have been looking for regardless. You've kind of always had the view or had the view recently that it would be a September and a December hike rather than back to back. I guess you guys are feeling pretty, pretty confident of that view now. Yeah, definitely, we're pretty confident on that view. And we also said, right, like apart from this big annual revisions to PCE, you have policy makers who aren't, you know, who it doesn't appear that they are, that there's a sense of urgency to tighten. And I think in one of the clear signals from a core FMC members. So New York Fed President Williams, he pushed back against October, how he's saying that, you know, there's no need for urgency. We need more time to accumulate data, which should provide more clarity. And yesterday, we heard from Jeff, vice chair Jefferson, who also said the same thing that, you know, we need more data to assess the balance of risks going forward. So I think that suggests that policy makers, they are not inclined to tighten in October. And as we have said time and again, that there is also a political component to it that's the meeting is really close to the midterm elections. So that might make some policy makers hesitant to move. And that's why we think that they're going to pause in October and then deliver a final hike in December. And if you look at comments from both the policy makers, they did say that some tightening later this year might be their base case. Brilliant, super clear ratio. Thanks very much. And it doesn't know there's a lot of data next if you get the Fed minutes, which probably I guess will confirm some of your way of thinking, but it's really the week after we get the CPI and the PPI numbers, I guess, when markets we really focused again on US data. So thanks again. And we'll speak to you soon. Thank you for having me. Well, away from the US, Europe's also been very much a focal point of the market this week, particularly France and some of the movements in bond yields around the French budget, which were sort of announced on the first of October. Josie Anderson, our European economist, is with me this week. Josie, thanks as always for joining. Thanks, Tom. So yeah, let's get into it on France. You know, in some respects, the market movements you saw, they were pretty extreme, but not necessarily coming off the back of any new information in some respects. Do you want to sort of maybe just talk around what the budget laid out and why France is facing in your view, sort of so much pressure? Yeah, thanks, Tom. So yeah, as we were recording this on Friday, kind of yesterday, when they announced the budget, was a roller coaster in terms of the OAT 10-year spread at the end of the day, 140 bips, and also Italy widened as well though. I'll know to about 120 bips in Spain through the 60 bips. And of course, budget concerns do remain at the forefront of investor's minds, and we saw this budget yesterday. I had quite ambitious plans, and these will have to face reality probably over the coming weeks as they're debated in Parliament. The plan is it stands, is fiscal consolidation of 54 billion euros in 2027, of which around 60% is spending cuts on things like pensions, public sector wages and sick pay, and that will bring the deficit down to 5% from 5.4% this year. But we know that without any fiscal intervention, the deficit would actually reach 6.5% next year, that's according to the Prime Minister. So of course, all of this budget, all of these announcements are playing into broader concerns around the fiscal situation, and how interest rates in general are higher than growth rate, and that can create kind of an negative snowball effects in terms of death accumulation and so there are major concerns around fiscal sustainability in France that's falling at least a large part of these moves in the market. Yeah, thanks Joe. So I mean, it's interesting because France's budget concerns and sense are nothing new. I feel like we've had this discussion every year for the last few years but clearly with the move higher in rates, it does become a bit more pressing in terms of that interest payment and then sort of the R-minus-G equation that you referenced. I guess just a quick one, I don't, you probably can't give me a straight answer on this exactly but you know, are we getting towards territory where some of the ECB sort of protection mechanisms might start to be used or do we think at the moment, you know, the markets would just sort of have to figure figure things out for themselves? Well, yeah, so people in the markets are questioning if the ECB will activate its transmission protection instrument which would allow it to kind of intervene in the market to support oats. I mean, I think most people in the market are saying that they don't expect the ECB to use it because this is being driven by something that is, you know, it is going on in France, not necessarily just disorderly markets. And so the consensus does seem to be that the ECB won't activate this, well, so called TPI. Yeah, I mean, that makes sense to me that it's a more of a local issue, although it was also interesting that you mentioned, I think, the cell of actually widening up the place like Italy as well. So plenty going on and plenty to keep watching. You know, you also mentioned the ECB, but in the context of bonds, but what about in the context of, I guess, their primary mandate in terms of inflation? We just had inflation data for September come out, you know, a little bit higher than the consensus was expecting it seems. Do we think that the pressures there still justify further rate hikes in the context of everything else that's happening? Yeah, I mean, so we've seen inflation rise to 3.8% year-on-year in September. That's on the HICP measure in the euro area. So, you know, approaching 4% now with the 2% target that's looking pretty high. But of course, a lot of the September rise was just driven by vehicle fuel prices. We don't have all the detail, but we already know that they rose a lot, of course, with higher oil prices during the month. So, core inflation is still lower, but it's rising, and we think that it's rising to an uncomfortable level in the ECB will hike again in December and then March next year. Obviously, fiscal system, fiscal issues and moves in bond markets will be a concern for the ECB. It'll be something that they're watching, but ultimately their primary mandate is inflation, and we do think higher inflation will drive them to hike twice more. Yeah, it's really notable to see how quickly actually the front end has reprised in Europe, you know, taking out some of those hikes that previously been priced in. So, definitely a lot going on there, not just to add inflation, maybe in some people's minds, what's happening with bond spreads as well. Clearly, it's going to be a big focus in the weeks ahead, and whether there are other measures that could be announced that could help to limit some of the upside pressure on inflation, you know, sort of diesel reserves release are being touted on the headlines as we speak. So, Europe certainly out the centre of attention. Thanks, Josie, and we'll speak to you soon. Thanks a lot, Dan. Well, we're going to finish this week in Asia, where I'm joined by Sunal Varma, our chief economist for Asia-X Japan. Sunal, thanks very much for coming on as always. We'll start with India, actually. We've got the RBI meeting this week. I was wondering if you could tell us not just what you're thinking about this meeting, but also a bit more broadly, because you published a piece talking about the cycle this time being a bit different. So, you know, what are you thinking about the RBI in that context? Yeah, Dom. So, for the RBI next week, I mean, we do think that the MPC is going to start its hiking cycle. So, expecting a 25 basis point hike, the stance we think will be left unchanged at neutral. In terms of the background, actually, core inflation has been very well-behaved in India, and, you know, we are in the 8th month of the Iran War. So, we've been surprised just how well-behaved the core has been, despite all these supply-side shocks. But at the margin, the upside risk from both food and energy prices are here. And so, we see the hike more as a preemptive move by the MPC to try to anchor expectations. Now, there will be some forecast revisions on the economic side. So, the CPF projections we think will get revised up from 5 to 5.2 percent given the higher food prices. GDP did surprise on the upside in the previous quarter. So, we think the growth projections will also get revised up from 6.7 to 7, but that's more of an MTM. Markets will also focus on, you know, any potential measures to tighten banking system liquidity because the diaspora bonds, the FCNRB inflows have resulted in, you know, substantial surplus liquidity in the banking system. So, measures to absorb liquidity could get announced, although, you know, this does not need to have, you know, come in the policy, they can also make the announcements outside the meeting. There are a number of tools that can be used like OMO sales, FXWOP, et cetera. But in terms of like the risk distribution to the policy outcome, we do think that, you know, we're assigning a 70 percent probability to our base case. And a fairly high 25 percent chance to an on hold decision and a very small probability of a 5 percent to a front loaded 50 basis point hike. And going back to your question, you know, the broader starting point for this RBI cycle, our view is, this RBI cycle is quite different. When we look at, and it's different in many, many ways actually, we don't see any signs of inflation generalization in India. In fact, the analysis we've done shows that the trend in super core inflation has dropped from 5 percent during 2015 to 2023. It was very sticky at 5 percent for a very long period of time. But that's completely collapsed to 3 percent now. And some of the forward-looking growth indicators we look at suggest that the resilient numbers that are ongoing right now will give way to some slowdown and consumer demand going forward. So all of this means that this is more of a fine tuning or recalibration in terms of the policy cycle and not the aggressive monetary policy tightening that markets are actually pricing in which is close to 125 basis point in total hikes. We think it's a 50 basis point hiking cycle including the 25 year expecting next week. Well, that's really interesting to me because, you know, from a sort of bystander's perspective, India does seem to be quite vulnerable potentially to a lot of the global supply shocks, whether it's energy, whether it's food. And you mentioned there sort of just how well-behaved core inflation has been. You know, is this something you're like that basically the compassist, I guess, given your forecast for a non-aggressive hiking cycle, a smaller hiking cycle, you know, does that tie into the idea that maybe India's vulnerabilities are not that great compared to the past? Well, I think CD vulnerability on supply side shocks is there and there's the shock from food prices and the shock from energy prices. Now, on food prices, I think this is where the risks are probably more material because the ongoing summer crop season actually has been relatively muted, I would say, below normal. And as we're entering into the winter cropping season water reservoir levels, which are essential for irrigation for the winter crops is also below normal. So it does look like production of some of the key crops will be below last year's level and India is a major player in global agriculture market. So if India either reduces import duty on certain crops or starts importing globally, for instance, it's importing sugar right now, then that will also push up global food prices. So I think food price inflation risks are real. But the thing is we are not seeing nominal salaries or nominal incomes increase. So when you have something like food which is so essential, sea price escalation, it does tend to eat into the real disposable income that consumers have. So we think the higher food inflation will actually lead to lower consumer spending on the discretionary side of the basket. The energy side, again, is a risk and I think from producer's perspective in particular, they are seeing an escalation in the input cost. But fuel prices for most consumers are actually controlled by government. So we've not seen price increases at the pump level since May this year. And at least as we get into the festive season, we have Diwali coming up in early November. It is quite unlikely that pump prices are going to get revised higher. So the energy price shall shock basically translates more into a shock for the twin deficits, your current account and fiscal balances coming under pressure than as suddenly showing up in higher CPI inflation. So full inflation overall therefore is more of a negative growth shock for India. Expectations are very well anchored, we are not seeing any second around effects. So despite the exposure on the supply side we think the broadening out of inflation pressures are unlikely to materialize this time around. Okay, really interesting. That's quite a lot in India. Just to look ahead to the dates coming out this week, you had a bit of CPI dates in the region, we've also got Malaysia's budget I think, any key highlights you wanted to flag there? Yeah, you know, all very important. So we will be getting CPI data for Thailand Philippines and Taiwan next week, we're looking at higher inflation across all the three economies and, you know, the common theme really is the rise in oil as well as food prices. So for Philippines we're expecting an acceleration from 6.1 to 7.1 percent. So that's quite material and we think it's going to come alongside higher core for Taiwan from 2 to 2.5 percent again with higher core and for Thailand from 2.5 to 3 but we don't think there will be a broadening of price pressures. So we think the should support our view of rate hike in Philippines and Taiwan going forward but none from Bank of Thailand. Malaysia budget will also be interesting, we're expecting a pause in fiscal consolidation with the fiscal deficit target, we think will be unchanged at 3.5 percent of GDP, this is for 2027. So Prime Minister Anwar, we think we'll shift to a more expansionary fiscal stance because the state election results have been on the weaker side. So we think the focus for him will be on containing the cost of living pressures. So more of these growth supportive measures for households and some for businesses. It could be some targeted subsidy rationalization and incentives for high value industries. So overall we think it's going to be a politically pragmatic budget. Brilliant, thanks Anwar, that's some super clear and super concise. So as always appreciate hearing your views not just on India but also on the broader backdrop. Also, one thing to watch in Asia generally, we do have Governor Ueda from the BHA speaking as well which will clearly be in focus with the market questioning whether the BHA could even hike back to back or whether it would be a slightly more delayed hiking cycle. So definitely something to watch from our side. That's it from the Asia section, thanks Anwar. Thank you, Don. Well, that's it for this week, we hope you enjoyed the week-head podcast which was edited and produced as ever by John Dalton. You can like and subscribe to Nomura's podcast on the usual channels, Apple, Spotify, SoundCloud and so on. And we'd also love to hear your feedback. So please do let us know what we can do better and what you want to hear more of by leaving a comment. We'd also love you to share the podcast far and wide with anyone you think may be interested. For more you can log into NomuraConnects.com to keep up to date and to keep on listening. Thanks once again and good luck for the week-head. 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