Dollar Flat as Markets Largely Unfazed by BOJ YCC Surprise

July 28, 2023
  • The surprise BOF YCC tweak has been more of a whimper than a bang so far; despite the BOJ surprise, we believe the divergence theme remains in full force; June core PCE will be very important; advance Q2 GDP data came in strong; Chile is expected to cut rates 75 bp to 10.5%
  • The two-day ECB meeting ended with the expected 25 bp hike; the real fireworks came during Lagarde’s press conference; ECB policymakers are split about what September may bring; eurozone July CPI and Q2 GDP data have started rolling out
  • The two-day BOJ meeting ended with unexpected tweak to YCC; Governor Ueda has lost all credibility as the BOJ remains an outlier in many different ways; July Tokyo CPI was reported ahead of the BOJ decision; Australia reported soft Q2 PPI and June retail sales data

The dollar is largely flat in the wake of the BOJ surprise. DXY traded as high as 102.042 earlier but is trading slightly lower near 101.689. Key level to watch is 102.046 as a break above sets up a test of the July high near 103.572. The euro is trading flat near $1.0985 but remains vulnerable after the ECB decision (see below) as clean break below $1.10 sets up a test of the July low near $1.0835. Sterling is trading higher near $1.2840 but clean break below $1.28 sets up a test of the late June low near $1.2590. USD/JPY traded as low 138.05 after the BOJ surprise (see below) before recovering to trade near 139.30. AUD is the worst performing major after weak PPI and retail sales data (see below). Despite the BOJ surprise, 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 this week as well as the economic data underscore the divergence theme and so further dollar gains seem likely.


The surprise Bank of Japan tweak to Yield Curve Control ended up being more of a whimper than a bang so far. USD/JPY tested the 138 area but has since recovered to trade flat near 139.40. Compare this to the nearly -4% drop after the December tweak. JGB yields have risen but after yesterday’s jump, UST yields are lower. European yields are higher but not by much. The Nikkei is down -0.4% and compares to the -2.5% drop after the December tweak. European stock markets are slightly lower while U.S. futures point to a higher open. The BOJ tweak has left the markets with more questions than answers (see below) and so perhaps that is why the reaction so far across all markets has been fairly muted.

Despite the BOJ surprise, we believe the divergence theme remains in full force. Despite the YCC tweak, the BOJ is not hiking rates anytime soon. After stronger than expected U.S. data, the European Central Bank delivered a very dovish message along with its 25 bp hike (see below). As such, the 2-year yield differentials should continue to move in the dollar’s favor. The euro and cable both had an outside down day yesterday that points to further losses ahead. Due to reports during the North American session that the Bank of Japan would discuss tweaking Yield Curve Control, USD/JPY gave up all of its earlier gains and had an outside down day as well yesterday. With so many moving parts across global markets, it may take a day or two for the fundamental story to settle in but we think the drivers for a strong dollar remain in play.

It all comes down to the strong data continue to underscore our belief that markets continue to underestimate the Fed’s capacity to tighten. Yesterday couldn’t have sent a clearer message. Growth above trend? Check. Labor market tight? Check. Forward looking strength in orders? Check. If this continues, the Fed is going to hike again. WIRP suggests odds of a hike September 20 around 20% but we think this should be at least a 50/50 proposition. Those odds top out near 40% November 1 but should move higher if the data remain firm.

June core PCE will be very important. Headline is expected at 3.0% y/y vs. 3.8% in May, while core is expected at 4.2% y/y vs. 4.6% in May. Of note, the Cleveland Fed’s inflation Nowcast sees the two at 3.0% y/y and 4.2% y/y, respectively, which are right at consensus. However, its model suggests both PCE measures will accelerate in July to 3.4% y/y and 4.5% y/y, respectively. The Fed is well aware of this and justifies Powell’s comments this week about not relying too much on just one month’s data. Personal income and spending will be reported at the same time. Income is expected at 0.5% m/m while spending is expected at 0.4% m/m. Real personal spending is expected at 0.3% m/m.

We get more labor market readings today. Q2 Employment Cost Index is expected at 1.1% q/q vs. 1.2% in Q1. If so, the y/y rate would likely fall a couple of ticks from 4.9% in Q1. While the Fed would probably be happy with the continued moderation, it would still be rather elevated. Elsewhere, University of Michigan reports its final July reading. The preliminary reading of 72.6 was the highest since September 2021 and this improvement would line up with the Conference Board.

The labor market remains tight. Initial claims came in at 221k vs. 235k expected and 228k last week, the lowest since late February. The 4-week moving average fell to 234k, the lowest since late May. Continuing claims came in at 1.69 mln vs. 1.75 mln expected and a revised 1.749 mln (was 1.754 mln) last week, the lowest since late January. Of note, the continuing claims data are reported with a one-week lag and so this week’s reading was for the BLS survey week containing the 12th of the month. Current consensus for July NFP stands at 190k vs. 209k in June.

Advance Q2 GDP data came in strong. The economy grew 2.4% SAAR vs. 1.8% expected and 2.0% in Q1. For those keeping score at home, that is four straight quarters of at or above trend growth at a time when the Fed is trying to get below trend growth. The Atlanta Fed will release its first GDPNow estimate for Q3 today. At this point, it's all pretty much guesswork for Q3 but the Q2 tracker was spot on. Personal consumption contributed 1.12 ppt to growth vs. 2.79 ppt in Q1 so it's slowing. Investment contributed 0.83 ppt but comes after three straight quarters of subtracting from growth and so it may be able to hold up in Q3. Government consumption contributed 0.45 ppt vs. 0.85 ppt in Q1 but has been a big contributor for four straight quarters. Can that hold up? We’re not so sure. Lastly, net exports subtracted -0.12 ppt after adding 0.58 ppt in Q1 and had been positive for four straight quarters. With global growth slowing, we doubt that holds up. Bottom line: there are risks ahead of slowing G and X but we think C and I can hold up.

Chile central bank is expected to cut rates 75 bp to 10.5%. However, the market is split. Of the 26 analysts polled by Bloomberg, 4 see a 100 bp cut, 17 see 75 bp, and 5 see 50 bp. At the last policy meeting June 19, the bank kept rates steady at 11.25% but the minutes opened the door to easing by noting that “All board members agreed that the recent evolution of the economy was going in the required direction. If those trends persist, the bank will start a rate cut cycle in the short term.” Since that meeting, real sector data came in weaker than expected while June CPI came in much lower than expected. Looking ahead, the swaps market is pricing in 225 bp of total easing over the next three months followed by another 200 bp over the subsequent three months, with the policy rate bottoming near 4.5% over the next two years. Such an aggressive easing cycle would surely weigh on the peso.


The two-day ECB meeting ended with the expected 25 bp hike. The ECB said it would continue to follow a data-dependent approach and that future decisions will ensure that rates remain “sufficiently restrictive.” Similar to its June statement, the bank said its APP portfolio would continue to decline at a “measured and predictable” pace and that PEPP reinvestments would run until at least end-2024. In a dovish tilt, the ECB said inflation will drop further over the remainder of the year. So far, everything was pretty much as expected except for the forecast of falling inflation. Updated forecasts won't come until the September meeting but this suggests downward revisions ahead.

The real fireworks came during President Lagarde’s press conference. Madame Lagarde seemed to highlight downside risks, noting that the economy is likely to remain weak in the short run as the near-term outlook has deteriorated. More importantly, she said the ECB has an open mind about its decisions in September and beyond, adding that September could be a hike or a pause, but not a cut. Recall that at the June meeting, Lagarde said that the ECB is not “thinking about” pausing. However, the fact that she mentioned it then suggests that the ECB was “thinking about thinking about” pausing. Now, it is clearly “thinking about” a pause and so it's removed one "thinking about" from the forward guidance. We don't want to beat a dead horse but the fact that she mentioned a cut (when no one else was even thinking about it) suggests the ECB is now "thinking about thinking about" a cut. The final nail in the coffin was when Madame Lagarde said she wouldn’t say at this time that the ECB has more ground to cover, something she said back in June.

ECB policymakers are split about what September may bring. Stournaras said a hike then would be the last, Vasle said the ECB could hike or pause then, while both Kazamir and Simkus said a pause then wouldn’t necessarily mean the tightening cycle was over. Muller and Villeroy said the next rate decisions aren’t obvious and will remain open. Markets are equally split as WIRP suggest odds of another 25 bp hike stand near 45% September 14, or basically a coin flip. 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 yesterday 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.

Eurozone July CPI readings have started rolling out. France, Spain, and Germany report today. France’s headline EU Harmonised inflation came in a tick lower than expected at 5.0% y/y vs. 5.3% in June, while Spain’s came in half a percentage point higher than expected at 2.1% y/y vs. 1.6% in June. More troubling is that Spain’s core measure came in at 6.2% y/y vs. 5…7% expected and 5.9% in June, the first acceleration since February. Germany reports later today and is expected at 6.6% y/y vs. 6.8% in June. Italy and eurozone report CPI Monday. The headline eurozone reading is expected at 5.2% y/y vs. 5.5% in June while core is expected at 5.3% y/y vs. 5.5% in June.

Eurozone Q2 GDP readings also started rolling out. France, Spain, and Germany reported today. France’s GDP growth came in at 0.5% q/q vs. 0.1% expected and a revised 0.1% (was 0.2% in Q1), Spain’s came in as expected at 0.4% q/q vs. a revised 0.5% (was 0.6%) in Q1, and Germany’s came in at 0.0% q/q vs. 0.1% expected and a revised -0.1% (was -0.3%) in Q1. France was a big surprise given that strikes had hobbled activity last quarter. Italy (0.0% q/q expected) and eurozone (0.2% q/q expected) report Q2 GDP Monday. Of note, Q1 eurozone growth was revised up last week to flat q/q vs. -0.1% in Q1 but we see downside risks to the Q2 reading. Either way, it’s clear that the U.S. economy will continue to outperform the eurozone this year.


The two-day Bank of Japan meeting ended with unexpected tweak to Yield Curve Control. But when is a tweak not a tweak? The bank said it would maintain the current 0.5% ceiling for the 10-year JGB yield but now called it a “reference point.” To make matters more confusing, the BOJ then offered to buy 10-year JGBs at 1.0% every day whilst keeping its key policy rate steady at -0.1%. Governor Ueda said “This isn’t a step toward normalization. We’re still far from where we can raise short-term rates.” Updated macro forecasts came in just like the press leaks suggested, with an upward revision to FY23 core inflation and a modest downward revision for FY24. To us, nothing in the forecasts suggests a need to normalize policy and yet Ueda threw the markets a huge curve ball.

Put simply, Governor Ueda has lost all credibility as the BOJ remains an outlier in many different ways. Yes, rates remain negative but more importantly, the BOJ has gone out of its way to confuse and surprise markets. Contrast that with the Fed, ECB, and other major central banks that strive for clear communication to the markets. While the forward guidance may not always turn out to be correct, the effort to convey policy convincingly is there. Most major central banks view forward guidance as a tool in and of itself. The BOJ? Apparently, not so much. Governor Ueda had a chance to establish credibility with the markets now that moment is gone.

Markets are already testing the BOJ, albeit cautiously. The 10-year JGB is now trading above the so-called “reference point” near 0.56% but remains far from the BOJ’s standing offer to buy at 1.0%. with inflation rising and increased confusion about the bank’s true aim, we suspect JGB yields will continue to rise. Of note, WIRP suggests odds of liftoff this year topping out near 25% December 19.

July Tokyo CPI was reported ahead of the BOJ decision. Headline came in at 3.2% y/y vs. 2.9% expected and 3.2% in June, while core (ex-fresh food) came in at 3.0% y/y vs. 2.9% expected and 3.2% in June. Lastly, core ex-energy came in at 4.0% y/y vs. 3.7% expected and 3.8% in June and is a new high for this cycle and the highest since April 1982. This suggests upside risks for the national CPI reading on August 18. This also illustrates how lower energy prices have driven headline CPI down whilst underlying price pressures continue to rise.

Australia reported soft Q2 PPI and June retail sales data. PPI came in at 3.9% y/y vs. 5.2% in Q1 and was the slowest since Q4 2021. More importantly, the 0.5% q/q rise was the smallest since Q1 2021. Elsewhere, retail sales came in at -0.8% m/m vs. flat expected and 0.7% in May. The y/y rate slowed to 2.3% vs. 4.1% in May and was the slowest since September 2021. RBA expectations continue to fall. WIRP suggests less than 10% odds of a hike August 1 vs. nearly 50% at the start of this week. It will all depend on the data but if the data continue to come in soft, we may have seen the end of the RBA’s tightening cycle.

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