Dollar Claws Back Recent Losses

September 12, 2023

Win Thin

It’s the calm before the storm; recent data suggest a pause by the Fed is likely next week; Brazil reports August IPCA inflation
Italian officials continue to jawbone the ECB; Germany reported a mixed September ZEW survey; U.K. reported soft labor market data;
New Zealand is facing wider than expected budget deficits; RBNZ is likely done hiking rates

The dollar is clawing back some of yesterday’s losses. DXY is trading higher near 104.800 and remains on track to test to March high near 105.883. The euro is trading lower near $1.0715 and remains on track to test the May low near $1.0635, while sterling is trading lower near $1.2465 and remains on track to test the May low near $1.2310. USD/JPY is trading just below 147 after trading as low as 145.90 yesterday. We believe the fundamental story remains in favor of the greenback. Looking through the recent noise, the U.S. remains in a much stronger position than the other major economies such as the eurozone or the U.K. Data this week should confirm our outlook and lead to ongoing dollar strength. Tomorrow’s CPI data should provide a bit of a spark.

AMERICAS

It’s the calm before the storm. There have been no U.S. data reports this week ahead of CPI tomorrow. With the media blackout in place, there are no Fed speakers this entire week. And yet we’ve had some movement in the FX market, courtesy of the BOJ and PBOC. Today, the dollar is clawing back some of yesterday’s losses as markets square up. With inflation data expected to show ongoing stickiness, we think it’s risky to go into tomorrow’s CPI report short dollars.

Recent data suggest a pause by the Fed is likely next week. WIRP suggests only 5% odds of a hike September 20. More likely, we will see the next hike November 1. By that November meeting, we will get one more jobs report and two each of CPI, PPI, retail sales, and PCE. If things go the way we expect for the U.S., the current 50% odds of a hike then are too low. The Cleveland Fed’s Nowcast model suggests upside risks for CPI tomorrow, with persistently high inflation seen in September as well. When all is said and done, headline inflation is creeping back up to the 3.5-4.0% range while core inflation remains stuck above 4%, even as financial conditions continue to loosen and the U.S. economy is growing above 5% SAAR in Q3.

Brazil reports August IPCA inflation. Headline is expected at 4.66% y/y vs. 3.99% in July. If so, it would be the second straight month of acceleration to the highest since February and approaching the top of the 1.75-4.75% target range. Next COPOM meeting is September 20 and the market is pricing in another 50 bp cut to 12.75%.

EUROPE/MIDDLE EAST/AFRICA

Italian officials continue to jawbone the ECB. Industry Minister Adolfo Urso warned that after “a policy of such continuous, rapid and decisive rate hikes by the ECB, we hope the next decision will be more rational.” This sort of jawboning by politicians is really a big no-no, especially coming just days before the ECB decision. However, the Meloni government has often criticized the ECB during this tightening cycle. Peripheral spreads have held up relatively well during the tightening cycle so far but we expect widening to pick up as the recession bites. That’s why Italy is being so vocal.

Former Italian Prime Minister and current European Commissioner Paolo Gentiloni tried to stay more upbeat on the eurozone outlook. He noted that “It’s too soon to say that we’re in a stagflation framework. The forecast is for 2023 growth of 0.8%. Is this something of long duration? Our estimate is that we will have probably a rebound already next year.” Yet Thursday’s decision is a real toss-up. Of the 55 analysts polled by Bloomberg, 30 see no change and 25 see a 25 bp hike to 4.0%. Similarly, WIRP suggest odds of a 25 bp hike stand near 40% but rise to 60% October 26 and top out near 70% December 14.

Germany reported a mixed September ZEW survey. Expectations came in at -11.4 vs. -15.0 expected and -12.3 in August, while current situation came in at -79.4 vs. -75.5 expected and -71.3 in August. Expectations are leveling out but current situation is the lowest since August 2020. Germany remains the biggest weak link in the eurozone as it suffers disproportionately from the slowdown in mainland China.

U.K. reported soft labor market data. Unemployment for the three months ended July rose a tick as expected to 4.3%, driven by -207k employed. This was the largest drop in employment since late 2020. The unemployment rate is the highest since September 2021 and nearly a full percentage point above the 3.5% low in August 2022. Applying the Sahm rule to the U.K., we already got the recession signal back in May, when the three-month average for the unemployment rate rose 4.0%, half a percentage point above that 3.5% low. Elsewhere, average weekly earnings came in at 8.5% y/y vs. 8.2% expected and a revised 8.4% (was 8.2%) previously. The U.K. data dump continues tomorrow with July GDP, IP, services, construction, and trade. With the labor market softening, the drag on the economy is likely to get worse and worse.

Bank of England tightening expectations have fallen sharply. WIRP suggests odds of a 25 bp hike September 21 are around 75%. For a time over the summer, a 50 bp hike was largely priced in and so the change is noteworthy. Odds of a second 25 bp hike are around 25% November 2 and then rise to top out near 50% February 1. However, the first cut is still not priced in until H2 2024. Yesterday, noted BOE hawk Mann said the bank should “err on the side of tightening further in order to prevent the risks of further inflation persistence from crystallizing.” She added that “Holding rates constant at the current level risks enabling further inflation persistence which will have to be unwound eventually with a worse trade-off.” Mann and Haskel both voted for a 50 bp hike at the last meeting August 3.

ASIA

New Zealand is facing wider than expected budget deficits. In its Pre-election Economic and Fiscal Update released today, Treasury forecasts the deficit to widen to -NZD11.4 bln ($6.7 bln) in FY 2024 vs. -NZD7.6 bln gap forecast in the May budget. The FY 2023 deficit was -NZD10 bln vs. -NZD7 bln forecast in May and a surplus is not expected until FY 2027, a year later than previously forecast. The update comes about a month ahead of the October14 general election and Finance Minister Grant Robertson said “The economy is turning a corner, but the challenges remain very real. This cannot be an election campaign where people are making big promises.” Not surprisingly, the government boosted its bond issuance plans by NZD9 bln over the next four years. The economy is already tipping into a mild recession and so Robertson has been forced into tightening fiscal policy at exactly the wrong time. Q2 GDP data will be reported September 21 and is likely to show the third straight quarterly contraction.

On the monetary policy side, the RBNZ is likely done hiking rates. Next policy meeting is October 4 and no change is expected. The bank is not expected to start easing until H2 2024.

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