Dollar Firm as Key Data Week Begins

July 31, 2023

Win Thin

The Fed outlook remains data-dependent and we get a lot of key data this week; the U.S. economy remains firm; Chicago PMI will be today’s highlight; Chile reports June IP and retail sales; Colombia is expected to keep rates steady at 13.25%
Eurozone reported July CPI and Q2 GDP; Germany reported weak June retail sales; U.K. reported June consumer credit
BOJ held an unscheduled bond-buying operation; Japan reported mixed real sector data; Australia reported soft June private sector credit; China reported soft official July PMIs

The dollar is slightly firmer as a key data week begins. DXY is trading higher near 101.679. Key level to watch is 102.046, which was tested Friday but held. Break above sets up a test of the July high near 103.572. The euro is trading higher near $1.1035 after firm data reported (see below) but remains vulnerable after the dovish ECB decision. Clean break below $1.10 sets up a test of the July low near $1.0835. Sterling is trading flat near $1.2860 ahead of the BOE decision Thursday (see below)and clean break below $1.28 sets up a test of the late June low near $1.2590. USD/JPY is trading higher near 142.35 as markets test the BOJ’s tolerance for higher yields and weaker yen (see below). Break above 142 sets up a test of the June 30 high near 145. We believe the relative fundamental story should continue to shift back in favor of the greenback. As we expected, the FOMC, ECB, and BOJ decisions last week as well as the economic data underscore the divergence theme and so further dollar gains seem likely.

AMERICAS

The Fed outlook remains data-dependent and we get a lot of key data this week. Jobs data Friday will be the main focus but we will get some PMI readings ahead of that (see below). WIRP suggests odds of a 25 bp hike September 20 are nearly 25% but this will clearly move higher if the data remain firm. Those odds top out near 40% November 1 but are also subject to change this week. Goolsbee speaks today. He has quickly emerged as one of the leading doves on the FOMC and so expect his remarks to reflect this.

The U.S. economy remains firm. How firm? After posting 2.4% SAAR growth in Q2, it appears that the momentum is carrying over into Q3. The Atlanta Fed’s initial GDPNow estimate for Q3 came in at 3.5% SAAR. We know this is likely to be revised significantly as the data come in and the first update comes tomorrow. The Atlanta Fed’s initial estimate for Q2 was 1.66% SAAR on April 28 and ranged between 1.64% and 2.89% before ending at 2.41% last week and lining up perfectly with the official Q2 reading. The economy remains robust and another quarter of growth at or above trend seems likely. Current Bloomberg consensus for Q3 is 1.5% SAAR.

Chicago PMI will be today’s highlight. Headline is expected at 43.4 vs. 41.5 in June. It will be a nice precursor to ISM readings later this week. Manufacturing PMI will be reported tomorrow, with headline expected at 46.9 vs. 46.0 in June. Keep an eye on employment and prices paid, which stood at 48.1 and 41.8 in June, respectively. ISM services PMI will be reported Thursday, with headline expected at 53.0 vs. 53.9 in June. Keep an eye on employment and prices paid, which stood at 53.1 and 54.1 in June, respectively. Regional Fed surveys for July wrap up this week, with Dallas Fed manufacturing survey today expected at -22.5 vs. -23.2 in June. Its services index will be reported tomorrow.

Chile reports June IP and retail sales. IP is expected at -4.0% y/y vs. -4.5% in May while sales are expected at -10.0% y/y vs. -10.5% in May. June GDP proxy will be reported tomorrow and is expected at -1.4% y/y vs. -2.0% in May. The economy remains weak and so the central bank started the easing cycle Friday with a dovish surprise, cutting rates 100 bp to 10.25% vs. 75 bp expected. The decision was unanimous and the bank warned that “The board estimates that, in the short term, the MPR will accumulate a somewhat stronger reduction than was considered in the Monetary Policy Report’s central scenario, in line with the results of the surveys conducted prior to this meeting.” The swaps market is pricing in 225 bp of easing over the next three months followed by another 200 bp over the subsequent three months. We expect USD/CLP to be very bid today when markets open.

Colombia central bank is expected to keep rates steady at 13.25%. At the last meeting June 30, it kept rates steady at 13.25% for the first time in nearly two years. Minutes to that meeting showed a cautious outlook, as the bank said inflation was “excessively high” and saw no condition for monetary easing. The bank publishes its quarterly monetary policy report Wednesday and could provide some insight into the timing of the first cut. The swaps market is pricing in 25 bp of easing over the next three months followed by another 150 bp over the subsequent three months.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported July CPI. Headline came in as expected at 5.3% y/y vs. 5.5% in June while core came in a tick higher than expected and remained steady at 5.5% y/y. Headline is below core for the first time since early 2021. While the decline in headline is welcome, we know ECB policymakers remain very concerned about sticky underlying inflation and the data bear that out. Italy also reported CPI and its EU Harmonised measure came in a tick lower than expected at 6.4% y/y vs. 6.7% in June.

Eurozone also reported Q2 GDP. Headline came in a tick higher than expected at 0.3% q/q vs. 0.0% in Q1, while the y/y rate also came in a tick higher than expected at 0.6% vs. 1.1% in Q1. Italy also reported Q2 GDP and came in at -0.3% q/q vs. 0.0% expected and 0.6% in Q1. This was the first quarter of growth since Q3 2022 and while the upside surprise is welcome, headwinds are building and so the H2 outlook remains weak. ECB President Lagarde was very downbeat in her economic assessment last week and we take her at her word. Of note, Portugal also came in weaker than expected at 0.0% q/q vs. 1.6% in Q1. We mention Portugal because officials there recently joined Italian ones in complaining about tight ECB policy and rising recession risks; the Q2 data from these two countries bear that out.

Market expectations for ECB policy remain subdued. WIRP suggest odds of another 25 bp hike stand near 35% September 14. Those odds rise to 60% October 26 and top out near 75% 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 be focusing 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.

Germany reported weak June retail sales. Sales came in at -0.8% m/m vs. -0.8% expected and a revised 1.9% (was 0.4%) in May. The y/y WDA rate improved to -1.6% vs. -2.1% in May but has contracted every month since May 2022. Italy reports retail sales Thursday. Eurozone then reports retail sales Friday and are expected at 0.3% m/m vs. 0.0% in May.

The U.K. reported June consumer credit. Credit rose GBP1.67 bln in June vs, GBP1.1 bln in May and was the biggest increase since April 2018. Of note, 54.7k mortgages were approved vs. 51.1k in May and were the most since October. The data come just ahead of the Bank of England decision Thursday, when it is expected to hike rates 25 bp to 5.25%. WIRP suggests odds of a 50 bp hike August 3 have fallen to 30% after being largely priced in at the start of the month. Looking ahead, 25 bp hikes September 21 and November 2 are priced in, while odds of one last 25 bp hike top out near 50% in Q1. This lower expected rate path would see the bank rate peak near 5.75% vs. 6.5% at the start of the month. This is a huge downward adjustment that is taking a toll on sterling. Updated macro forecasts will be released and we expect upward revisions for inflation and downward revisions for growth.

ASIA

The Bank of Japan held an unscheduled bond-buying operation. The bank offered to buy JPY300 bln of 5- to 10-year JGBs at market yields, the first unscheduled operation since February. Ahead of the operation, the key 10-year yield had risen to 0.605%, above the 0.5% “reference point” but far below the BOJ’s standing offer to buy at 1.0%. The move still leaves markets guessing as to what the BOJ really wants to accomplish by its surprise tweak to Yield Curve Control. The reluctance to allow JGB yields to rise too much is unequivocally dovish and so we remain bullish USD/JPY. Not only because the BOJ remains far from liftoff, but also because we think the markets will test the BOJ’s appetite for higher yields and a weaker yen as the BOJ and Ueda have lost credibility. We are already trading above the 142 high from July 21 and this sets up a test of the 145 high from June 30.

Japan reported mixed real sector data. June retail sales, IP, and housing starts were all reported. Sales came in at 5.9% y/y vs. 5.4% expected and 5.8% in May, IP came in at -0.4% y/y vs. 0.3% expected and 4.2% in May, and starts came in at -4.8% y/y vs. -0.5% expected and 3.5% in May. The data continue to soften and are likely to keep the BOJ reluctant to remove accommodation.

Australia reported soft June private sector credit. It was expected to remain steady at 0.4% m/m but instead came in at 0.2%. The y/y rate fell to 5.5% y/y vs. 6.2% in May and was the lowest since September 2021. The data come just a day before the Reserve Bank of Australia meeting, when it is expected to hike rates 25 bp to 4.35%. However, of the 26 analysts polled by Bloomberg, nearly half look for steady rates. WIRP suggests only 15% odds of a hike this week, which seems way too low. At the last meeting July 4, the bank left rates steady at 4.10% and noted that “Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve. The decision to hold interest rates steady this month provides the Board with more time to assess the state of the economy and the economic outlook and associated risks.” Since then, the data have come in mixed and so it’s a very close call. We lean towards a 25 bp hike accompanied by a statement acknowledging another pause. The RBA releases its Statement on Monetary Policy Friday that will contain new macro forecasts.

China reported soft official July PMIs. Manufacturing came in at 49.3 vs. 48.9 expected and 49.0 in June, while non-manufacturing came in at 51.5 vs. 53.0 expected and 53.2 in June. As a result, the composite PMI fell to 51.1 vs. 52.3 in June and was the lowest since December. Caixin reports its manufacturing PMI tomorrow and is expected at 50.1 vs. 50.5 in June. Its services and composite PMIs will be reported Thursday. Services is expected at 52.4 vs. 53.9 in June. If so, the Caixin composite PMI would likely fall by over a point vs. 52.5 in June. With the economy still slowing, more stimulus is likely to be seen in Q3.

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