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Overview: A consolidative tone has emerged ahead of the outcome of the FOMC meeting later today. The focus is not so much on the 75 bp rate hike, but on its forward guidance. Many expect the Fed to signal it will return to a 50 bp move next month, but we are not convinced that it will go beyond indicating that 50 bp or 75 bp will be debated in December, depending on the data. The market has a 5% terminal rate discounted. The Fed does not need to validate it now. Next month it updates the dot plot and that is a more reasonable forum. Equities in Asia Pacific and Europe rose. US futures are slightly firmer. Benchmark 10-year yields are mixed. The US is flat at around 4.04%, while European yields are mostly 1-3 bp firmer. The dollar is trading with a lower bias, with the fear of intervention tomorrow when Tokyo markets are closed, and is helping the yen lead the charge, followed by the Antipodean currencies. Emerging market currencies are broadly mixed. Gold is extending its recovery after posting an outside-up day yesterday. It is near $1655 after testing $1631 yesterday. December WTI is flat around $88.30. It rallied 2.1% Tuesday. US natgas remains volatile and is up nearly 4.5% today after dropping 10% yesterday. Europe’s benchmark collapsed 23.6% Monday and jumped 39% yesterday. It is up 8% today. Iron ore snapped a six-day slide yesterday with a 1.2% gain. It is built on that today with a 3.1% gain, the most in nearly two months. December copper rose 2.9% yesterday and is up about 0.5% today. The resumption of grain shipments from Ukraine appears to be capping wheat prices after the December contract rose more than 8.5% over the past two sessions. It is off about 0.85% now.
 

Asia Pacific

Japan's markets are closed tomorrow, but the market recalls that after the September Fed hike, the BOJ intervened the following day. Yet, the intervention does not appear to have been aimed at a certain level, like JPY150 but at volatility. Volatility is also directional in the sense that it has tended to increase when the dollar trades at levels it has not seen in decades. Three-month implied volatility reached almost 15% last month (October 21-24) and has been now holdings below 13% for the sixth session. Separately, BOJ Governor Kuroda suggested that adjusting the yield curve control policy may be appropriate but not quite yet. Kuroda's term ends next April. Many do not expect the BOJ to adjust policy before then, though Kuroda has opened the door a bit to an earlier move.

Chinese and Hong Kong stocks extended yesterday's sharp gains today amid speculation that the zero-Covid policy may be tempered soon. Yet, nothing seems imminent. The modification to the policy looks to be about the process rather than substantive. For example, the restrictions and lockdowns come with little fanfare or announcements. That appears to have been the case in Zhengzhou, for example, and Lanzhou. Reports suggest that since the 20th Party Congress ended, zero-Covid efforts have intensified. Still, the number of cases yesterday was near three-month highs. Lockdowns have recently been announced for two districts in Wuhan--Hanyang and Jiangan--in what has been described as a "targeted approach." Several other areas, including Guangzhou, Fuzhou, and Shanghai are also imposing restrictions on small areas of neighborhoods. Reports suggest school closures are not widely announced but told to families verbally or via social media apps. Flights are also being quietly canceled. One report estimated that on Monday, more than 8k flights were canceled and 4.2k were completed. On the same day in 2019, 11.7k flights were completed.

The dollar began the Asia Pacific session on its highs around JPY148.35 and has trended lower to test JPY147.00. Yesterday's low was a smidgeon lower. Support extends to JPY146.80. That area looks likely to hold now. Initial resistance is seen near JPY147.50, and a break above it would initially target JPY148.50. The Australian dollar is firm but within yesterday's range (~$0.6375-$0.6465). It appears to have forged a shelf below $0.6400, but yesterday's high seems a bit of a stretch ahead of the outcome of the FOMC meeting. After a wide range yesterday, the Chinese yuan traded in its narrowest range in more than a week (~CNY7.2665-CNY7.2875). The PBOC set the dollar's reference rate at CNY7.2197 compared with expectations (median in Bloomberg's survey) for CNY7.2840. The offshore yuan also consolidated in quiet turnover today. 
 

Europe

The Eurozone's October manufacturing PMI was unchanged from the preliminary reading of 46.6. It has fallen every month since January, and it is the fourth month below the 50 boom/bust level. However, the national figures for the Big 4 were all poorer than expected. However, the German reading was revised to 45.1 from 45.7 and down from 47.8 in September. France's flash estimate of 47.4 was shaved to 47.2 from 47.7. Italy's October manufacturing PMI fell to 46.5 from 48.3. The median forecast in Bloomberg's survey was 46.9. Spain tumbled to 44.7 from 49.0 and was also well below expectations (median forecast 47.5).

Separately, Germany reported a larger-than-expected September trade surplus of 3.7 bln euros. The market had expected a much smaller improvement from August's 1.2 bln euro surplus. Nevertheless, the details were poor. Exports fell 0.5%, while they were expected to have risen by as much. The "saving grace" was the sharp upward revision to August exports (2.9% vs. 1.6%). Imports reflected weak domestic demand, and fell a dramatic 2.3%, nearly four times more than expected. August imports were revised to show a 4.9% gain instead of 3.4%, which was originally reported. Lastly, Germany also reported October's unemployment rate was steady at 5.5%.

The euro is in a little more than a third of the cent range today above $0.9870. It met offers in early European turnover slightly above $0.9900. Yesterday's low was near $0.9850 and the 20-day moving average is around $0.9840. A break of this area weakens the technical tone. The intraday momentum indicators suggest consolidative trading is likely at least ahead of the FOMC's announcement. Similarly, sterling is confined to a narrow range inside yesterday. It is in about a quarter-of-a-cent range on either side of $1.1500. It looks a bit soft, though, and the risk is for a range extension on the downside. We note that the unexpected re-election of Prime Minister Frederiksen in Denmark has not seen much of a market reaction. The Israeli shekel is weaker for the fifth consecutive session and seems largely unmoved by the return of Netanyahu and Likud after the fifth election in four years with the slimmest of majorities.
 

America

The key issue is not the magnitude of the Fed's hike today. A three-quarters-point hike is as foregone a conclusion as these things get. The issue is what is next. For a couple of months, some officials have intimated that the Fed may soon slow the pace. That would seem to make sense as the target rate moves above what Fed officials see as neutral and into restrictive territory. It is well appreciated that monetary policy impacts with a lag. Yet, it seems unlikely that Chair Powell simply pre-announces a 50 bp hike for the December 14 meeting. It seems unnecessary for Powell to go beyond his previous guidance that the debate at the FOMC is likely between 50 bp and 75 bp. At least partly, it is about risk management. Core CPI made a new cyclical high in September and it looks to ease ever so slightly last month. The report is out next week, and another firm reading is expected (a 0.5% increase in the core and 0.7% at the headline level). Two days before next month's FOMC meeting concludes, this month's CPI will be reported. We assume the key working directive is not to get bitten by the same dog twice. Many banks and economists see Powell talking about a higher terminal rate, ostensibly so that its signal of slower increases is not seen as a pivot. Some banks have revised their terminal rate to 4.75%-5.00%. However, the market is already there. Moreover, such a signal by Powell, which might not materialize, would validate market expectations, which is worth something, but it would not be leading the market.

There are three other issues that will likely be addressed in Powell's press conference, probably through the Q&A. First is liquidity in the Treasury market. Treasury Secretary Yellen has already recognized and there continues to be speculation that the Treasury will launch a buyback program to boost liquidity in the on-the-run issues and retire some of the less liquid off-the-run issues. Second is that the Fed's divestment of agency debt is below target. The issue is whether the Fed should be more assertive and sell directly. We suspect the Fed is not in a hurry to do so. The third issue involves the Fed's negative operating income. The interest pays out on required and excess reserves are greater than the interest earned on its bond holdings. Last year, the Fed earned more and transferred $109 bln back to Treasury. In 2020, it sent Treasury about $87 bln. Unlike private sector banks, the Federal Reserve addresses the negative income by an accounting measure (deferred asset) that is a bit like a marker, which it will cover when it begins making a profit again. This may be a multi-year process, and the loss of operating income can be expected to grow. Congress chose to fund the Consumer Financial Protection Bureau with the funds transferred by the Fed back to Treasury rather than congressional appropriations. There is a bill in Congress that would prevent the Fed from funding the operations when it is reporting on operating loss.

The US dollar is trading with a heavier bias against the Canadian dollar. It is straddling the CAD1.3600 level in quiet turnover. It settled near CAD1.3630 yesterday after recovering from CAD1.3530. A convincing break of CAD1.35 would lend credence to the idea that a large top is being carved. A firmer greenback may be likely in early North American activity, and the CAD1.3620-40 area may be re-tested. The CAD 1.3670-CAD1.3685 offers the nearby cap. The US dollar convincingly broke out of the MXN19.80-MXN20.20 range that has dominated since mid-August. It settled below MXN19.75 yesterday, its lowest level in five months. It briefly traded below MXN19.70 today. There is little chart support ahead of MXN19.60. Initial resistance is now seen in the MXN19.76 area. The transition to a new government in Brazil has begun. Bolsonaro has conceded in deed if not a word. The US dollar fell for the fourth consecutive session yesterday and briefly traded below BRL5.10 after trading as high as BRL5.40 early Monday.

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