- The divide between the Fed hawks and doves is widening; it’s clear why the doves are getting a bit cocky; U.S. Treasury yields continue to rise at the long end
- Germany reported weak June IP; market expectations for ECB policy remain subdued
- BOJ released its summary of opinion for the July meeting; Japan civil servants may get the biggest pay raise in over 25 years
The dollar is recovering from the post-jobs selloff. DXY is trading higher near 102.367 after two straight down days and remains on track to test the July high near 103.572. The euro is trading lower near $1.0970 and remains on track to test the July low near $1.0835. Sterling is trading lower near $1.2725 and remains on track to test the late June low near $1.2590. USD/JPY is trading higher near 142.40 and remains on track to test the June 30 high near 145. Despite the softish jobs 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 economic data underscore the divergence theme and so further dollar gains seem likely.
The divide between the Fed hawks and doves is widening. Over the weekend, Governor Bowman pushed back against the dovish narrate and stressed "The recent lower inflation reading was positive, but I will be looking for consistent evidence that inflation is on a meaningful path down toward our 2% goal as I consider further rate increases and how long the federal funds rate will need to remain at a restrictive level." She added that she expects “additional rate increase will likely be needed” to get inflation back to target. Last week brought a flurry of dovish comments from Goolsbee, Bostic, and Barkin. Bostic and Bowman speak today and so we are likely to see a hawk vs. dove messaging battle play out on the tapes.
Yet it’s clear why the doves are getting a bit cocky. The U.S. economy remains robust and price pressures are easing. The Atlanta Fed’s GDPNow model is currently tracking Q3 growth at 3.9% SAAR vs. 2.4% in Q2. Of course, that rate is likely to come down as the data come in but the momentum is undeniable. Next model update comes tomorrow. Even as the economy remains robust, inflation has come down significantly. However, as we’ve pointed out before, the easy part is getting from 8% to 4%; the hard part is getting it from 4% to 2%. Because of this, we believe the markets continue to underestimate the Fed’s capacity to tighten. WIRP suggests odds of a hike September 20 are around 15% but we think this should be much higher. Those odds top out near 40% November 1 but as always, it will all come down to the data. CPI and PPI reports later this week will be key for the near-term direction in markets.
U.S. Treasury yields continue to rise at the long end. Last week brought a perfect storm of bond-negative news: the U.S. Treasury boosted its estimates for Q3 issuance to $1 trln vs. $733 bln seen back in May, Fitch downgraded the U.S. to AA+, the BOJ tweaked Yield Curve Control, and data out of the U.S. remained strong. On their own, each of these drivers might have had a little impact but taken together, the floodgates opened. The supply will remain relentless, as Treasury estimates Q4 issuance of $852 bln and so it’s hard to make a case for lower yields. Against this backdrop of elevated yields, the U.S. Treasury holds its quarterly refunding this week. The total of $103 bln will be sold, beginning with the $42 bln auction of 3-year notes tomorrow. Today, June consumer credit will be reported and is expected at $13.55 bln vs. $7.24 bln in May.
Germany reported weak June IP. IP came in at -1.5% m/m vs. -0.5% expected and a revised -0.1% (was -0.2%) in May. The y/y rate plunged to -1.7% vs. -0.2% expected and a revised 0.0% (was 0.7%). This was the first negative reading since January. Eurozone IP won’t be reported until next Wednesday but it will likely be a weak reading after Germany’s downside surprise.
Market expectations for ECB policy remain subdued. WIRP suggest odds of a 25 bp hike stand near 40% September 14, rise to 60% October 26 and top out near 70% 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.
Bank of Japan released its summary of opinion for the July meeting. At that meeting, the bank surprised the markets with a tweak to Yield Curve Control. One board member felt the sustainable 2% inflation target was clearly in sight. One said it’s important for the BOJ to give consideration to market functioning to encourage investments in bonds that have been held back by high uncertainties. Another board member said it’s important to let interest rates be set by market forces as much as possible. It does seem that the BOJ is starting to tiptoe towards an eventual elimination of YCC followed by liftoff. However, the summary of opinions suggests it will be a very long slog, as only one member felt confident about achieving sustainable 2% inflation. Next policy meeting is September 21-22 and no change is expected then. Until there is more clarity, we expect the market to continue testing the BOJ by pushing yields higher.
Japan civil servants may get the biggest pay raise in over 25 years. The National Personnel Authority recommended that average monthly salaries for public sector workers be increased by 2.7% in the current FY23. This includes a base pay increase of around 1%, the largest in 26 years. Private sector salaried workers are also set to see wages increase by more than 3% this FY, according to trade union group Rengo, while non-salaried workers will likely see the national minimum wage rise by more than 4%. Higher wages have been something the BOJ wants to see before it tightens policy and so these developments are noteworthy. June cash earnings data will be reported tomorrow. Nominal earnings are expected to pick up a tick to 3.0% y/y while real earnings are expected to remain steady at -0.9% y/y. If so, it would be disappointingly weak given the wage deals announced so far. With real wages still falling, it’s no surprise then that household spending is expected at -3.8% y/y vs. -4.0% in May.