Dollar Consolidates as China News Worsens

August 16, 2023
  • July retail sales were strong; recent softish inflation data support a September skip but the strong real sector data complicates things; FOMC minutes will be very important; Canada reported mixed July CPI data
  • Eurozone reported revised Q2 GDP data and June IP; U.K. reported July CPI data; Eastern European economies continues to struggle
  • RBNZ kept rates steady at 5.5%, as expected; Fitch said it may reconsider China’s A+ sovereign credit rating; private wealth manager Zhongrong reportedly missed payments on dozens of its financial products

The dollar continues to consolidate its recent gains. DXY is trading modestly lower near 103.065 after four straight up days. We still look for a test of the July 6 near 103.572. Let's take things a step at a time but if that July high goes, it would set up a test of May 31 high near 104.699. The euro is trading higher near $1.0920 but remains on track to test the July low near $1.0835. Sterling is trading higher near $1.2740 after higher than expected CPI data (see below) but remains on track to test the late June low near $1.2590. USD/JPY is trading flat near 145.65 after it traded at a new high for this move near 145.85 yesterday. The pair remains on track to test the 150 area. Despite the softish jobs and CPI data, we believe the relative fundamental story should continue to move in favor of the greenback. As we expected, the recent FOMC, ECB, and BOJ decisions as well as the ongoing economic data underscore the divergence theme and so further dollar gains seem likely.


July retail sales were strong. Headline came in at 0.7% m/m vs. 0.4% expected and a revised 0.3% (was 0.2%) in June, while sales ex-auto came in at 1.0% m/m vs. 0.4% expected and 0.2% in June. The so-called control group used for GDP calculations came in at 1.0% m/m vs. 0.5% expected and a revised 0.5% (was 0.6%) in June. The y/y rate for the control group came in at 5.0% y/y vs. 3.8% in June and was the strongest since February. Personal spending (which covers services too) will be reported August 31 and is also likely to accelerate from June. Consumption remains fairly strong, boosted by the firm labor market and solid wage gains as well as relatively loose financial conditions.

The U.S. economy continues to run hot. The Atlanta Fed’s GDPNow model is currently tracking Q3 growth at 5.0% SAAR after yesterday’s data, up from 4.1% previously. The next model update comes today after the data. Until financial conditions tighten more, the economy is unlikely to grow below trend. Chicago Fed weekly financial conditions will be reported today.

While recent softish inflation data support a September skip, the strong real sector data complicates things. With the economy still growing well above trend, there are clearly some underlying inflation risks that cannot be ignored and so we still don't think the Fed is done hiking. The market seems to agree with us as WIRP suggests 10% odds of a hike in September, rising to nearly 40% in November. Both should be higher. Kashkari provided some hawkish guidance yesterday. He asked “Are we done raising rates? I’m not ready to say that we’re done. But I’m seeing positive signs that say, hey, we may be on our way — we can take a little bit more time to see, get some more data and before we decide whether we need to do more.”

FOMC minutes will be very important. At the July 25-26 meeting, the Fed hiked rates 25 bp and noted that “Recent indicators suggest that economic activity has been expanding at a moderate pace. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated.” Powell stayed on message and stressed that the Fed hasn’t made a decision to hike at every other meeting, adding that it would hike in September if the data warranted. Powell said the slowdown in June CPI was welcome but stressed it was only one month. He said the Fed needs to stay “on task” and that the Fed needs to hold rates “for some time.”

Other data will be reported. July IP is expected at 0.3% m/m vs. -0.5% in June. July building permits and housing starts will also be reported. Permits are expected at 1.9% m/m vs. -3.7% in June, while starts are expected at 0.8% m/m vs. -8.0% in June. Yesterday, August NAHB housing market index came in at 50 vs. 56 expected and actual in July. The housing sector has remained remarkably resilient even as the average national 30-year fixed mortgage rate has risen. It ended last week at 7.53%, the highest since September 2000.

Canada reported mixed July CPI data. Headline came in at 3.3% y/y vs. 3.0% expected and 2.8% in June. it was the first acceleration since April and moves back above the 1-3% target range. Base effects are low in H2 and so there will be some further upward pressure on the y/y rate in the coming months. Of note, CPI ex-gasoline prices rose 4.1% y/y and shows hos lower energy prices have helped headline drop. With energy prices on the upswing again, this presents upward risks to headline. Elsewhere, all three core measures fell from June but there are enough blinking yellow lights in the CPI data to warrant some caution by the BOC. Odds of a hike September 6 rose to 33% from less than 25% yesterday, while peak odds rose to 85% January 24 from 70% yesterday.


Eurozone reported revised Q2 GDP data and June IP. GDP growth was unchanged from the preliminary at 0.3% q/q and 0.6 % y/y. IP came in at 0.5% m/m vs. 0.0% expected and a revised 0.0% (was 0.2%) in May, while the y/y rate came in at -1.2% vs. -4.0% expected and a revised -2.5% (was -2.2%) in May.

Market expectations for ECB policy remain subdued. WIRP suggest odds of a 25 bp hike stand near 50% September 14, rise to near 75% October 26 and top out near 80% December 14. These odds will rise and fall with the data but Madame Lagarde clearly accentuated the negative last week and that’s what markets should focus on. What’s very interesting to us is that the ECB may stop hiking before the Fed does and we don't think the markets have priced this risk in yet.

The U.K. reported July CPI data. Headline came in at 6.8% y/y vs. 7.9% in June, core came in steady at 6.9% y/y, and CPIH came in at 6.4% y/y vs. 7.3% in June. All three were a tick higher than expected but headline was still the lowest since February 2022 but still well above the 2% target. The Bank of England tightening expectation have picked up. WIRP suggests over 20% odds of a 50 bp hike September 21, while 25 bp hikes are priced in for November 2 and February 1 that would see the bank rate peak near 6.0% vs. 5.75% at the start of this week and 6.5% at the start of last month.

The Eastern European economies continues to struggle. Poland Q2 GDP came in at -3.7% q/q vs. -2.3% expected and 3.8% in Q1, while the y/y rate came in at -0.5% vs. -0.3% expected and actual in Q1. Elsewhere, Hungary Q2 GDP came in at -0.3% q/q vs. 0.2% expected and a revised -0.4% (was -0.3%) in Q1, while the y/y rate came in at -2.4% vs. -1.4% expected and -0.9% in Q1. Czech Republic reported Q2 GDP last month at 0.1% q/q and -0.6% y/y. With all three slipping into recession, no wonder their central banks are under pressure to cut rates. So far, only Hungary has but the other two are widely expected to begin easing over the next three months. With inflation still running high in all three, pressure will likely be brought to bear on their currencies.


Reserve Bank of New Zealand kept rates steady at 5.5%, as expected. However, it was a hawkish hold as the expected rate path now shows some odds of one last hike in early 2024 as well as steady rates through all of 2024. The bank noted that “The Committee agreed that the OCR needs to stay at restrictive levels for the foreseeable future to ensure annual consumer price inflation returns to the 1-3% target range. In the near term, there is a risk that activity and inflation measures do not slow as much as expected.” This seems a bit too hawkish given GDP has contracted two straight quarters. Updated macro forecasts see slightly higher inflation in 2024 as well as minor tweaks to growth. It remains to be seen whether the RBNZ is eventually forced to restart the tightening cycle but for now, WIRP suggests 10% odds of a hike October 4, rising to 33% November 29 and then topping out around 45% February 28. The swaps markets sees some odds of easing starting in H2 2024, which is at odds with the RBNZ’s rate path. Q2 PPI data will be reported tomorrow.

Fitch said it may reconsider China’s A+ sovereign credit rating. Agency official said “We might think again, because the debt-to-GDP ratio is a little bit on the high side for a single ‘A’ credit.” He added that there were upside risks to this ratio if China is forced to take on liabilities in the corporate and banking sector and become “real liabilities for the government,” though he added that Fitch does not expect this to happen. Of note, S&P also has China at A+, as does Moody’s with its equivalent A1 rating.

Private wealth manager Zhongrong reportedly missed payments on dozens of its financial products. It said it has no immediate plans to make investors whole as its short-term liquidity has “suddenly” dried up. Zhongrong is partly owned by Zhongzhi, the firm that itself missed payments on its high yield products recently. Lastly, China regulators have reportedly asked some investment funds not to be net sellers of equities this week. This is the channel through which the sovereign becomes affected. If policymakers are eventually forced to make investors whole, those liabilities move on to the sovereign balance sheet and Fitch’s fears come true. Stay tuned.

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