Dollar Remains Under Pressure as Key Week Begins

August 01, 2022

Win Thin

Markets are still digesting last week’s FOMC decision; we think Fed officials will push back against the market’s dovish take on its decision; the U.S. rates market continues to price in gloom and doom; ISM reports July manufacturing PMI
Eurozone final July manufacturing PMI readings were reported; Germany continues to weaken; ECB tightening expectations remain depressed despite CPI and GDP data last week
Caixin reported soft China July manufacturing PMI; Hong Kong reported weak Q2 GDP data

The dollar remains under pressure as the week begins. DXY is down for the fourth straight day and trading at new lows for this move near 105.43, the lowest since July 5. The June 27 low near 103.673 is coming into view. The yen continues to lead this move, with USD/JPY trading as low as 131.90 today. The June 16 low near 131.50 is likely to be tested soon and a break below would set up a test of the May 24 low near 126.35. The euro is inching above $1.0250 but remains constrained by weak eurozone data and lower ECB tightening expectations (see below). Sterling traded at the highest level since June 28 near $1.2260 today and appears on track to test the June 16 high near $1.2405. We maintain our strong dollar call and believe that markets are misreading the Fed’s commitment to lowering inflation. However, the greenback is unlikely to get much traction in the absence of any strong economic data. This week’s readings will be key for the medium-term dollar outlook.

AMERICAS

Markets are still digesting last week’s FOMC decision. WIRP suggests a 50 bp hike September 21 is fully priced in, with 30% odds of a larger 75 bp move. The swaps market is now pricing in 100 bp of tightening over the next 6 months that would see the Fed Funds rate peak near 3.50%, followed by 50 bp of easing over the subsequent 6 months. We cannot believe that the Fed would make such a quick pivot with inflation still well above target and the labor market at full employment.

We think Fed officials will push back against the market’s dovish take on its decision. With the media blackout over, prepare for more Fed comments that tilt decidedly hawkish. Evans, Mester, and Bullard speak Tuesday. Mester speaks again Thursday. Over the weekend, uber-dove Kashkari reiterated that the Fed is focused on lower inflation, noting that “We are committed to bringing inflation down and we’re going to do what we need to do. We are a long way away from achieving an economy that is back at 2% inflation, and that’s where we need to get to.” We concur.

The U.S. rates market continues to price in gloom and doom. The 10-yearyield traded as low as 2.62% Friday, the lowest since April before recovering to trade near 2.66% currently, while the 2-year yield traded as low as 2.82% before recovering to trade near 2.90% currently. As a result, the 2- to 10-year curve remains inverted near -24 bp while the 3-month to 10-year curve is currently at 34 bp and moving closer to inversion. This remains concerning to us and yet Fed officials have not really pushed back against the inversion trade in recent weeks.

ISM reports July manufacturing PMI. Headline is expected at 52.0 vs. 53.0 in June, while prices paid is expected at 73.5 vs. 78.5 in June and employment is expected at 48.2 vs. 47.3 in June. Services will be reported Wednesday. Headline is expected at 53.7 vs. 55.3 in June. Last week, Chicago PMI came in at 52.1 vs. 55.0 expected and 56.0 in June, and was the weakest since August 2020. Preliminary July PMI readings from S&P Global were also weak and so there are downside risks to ISM this week. June construction spending will also be reported and is expected at 0.2% m/m vs. -0.1% in May.

EUROPE/MIDDLE EAST/AFRICA

Eurozone final July manufacturing PMI readings were reported. Headline picked up two ticks from the preliminary to 49.8. Germany rose a tick to 49.3 while France feel a tick to 49.5. Italy and Spain were reported for the first time and fell sharply from June to 48.5 and 48.7, respectively. The manufacturing sectors in the four largest eurozone economies are all contracting together for the first time since mid-2020. Final services and composite will be reported Wednesday. Here too, Italy and Spain will be reported for the first time and their composite PMIs are expected to fall sharply from June to 49.7 and 51.5, respectively.

Germany continues to weaken. June retail sales came in at -1.6% m/m vs. 0.3% expected and 1.2% in May. This dragged the y/y WDA rate down to -8.8% vs. -3.0% in May. Trade data will be reported Wednesday. Factory orders will be reported Thursday and are expect at -0.7% m/m s. 0.1% in May. IP will be reported Friday and is expected at -0.2% m/m vs. 0.2% in May. There are clear downside risks to all the German data after its composite PMI fell below 50 in July to 48.0, the lowest since June 2020.

ECB tightening expectations remain depressed despite CPI and GDP data last week. WIRP suggests 50 bp hikes are no longer priced in for the next meetings September 8 and October 27. Looking ahead, the swaps market is now pricing in 100 bp of tightening over the next 12 months that would see the deposit rate rise to 1.0%, with some odds seen of another 25 bp hike to 1.25% thereafter. This has fallen sharply despite still-high inflation readings, as weak data and the threat of energy shortages have raised recession concerns.

ASIA

Caixin reported soft China July manufacturing PMI. It came in at 50.4 vs. 51.5 expected and 51.7 in June. Its services and composite PMI readings will be reported Wednesday. Services is expected to come in at 54.0 vs. 54.5 in June. Over the weekend, weak official PMI readings were reported. Manufacturing came in at 49.0 vs. 50.2 in June, non-manufacturing came in at 53.8 vs. 54.7 in June, and the composite came in at 52.5 vs. 54.1 in June.

Hong Kong reported weak Q2 GDP data. Growth came in at 0.9% q/q vs. 3.0% expected and a revised -2.9% (was -3.0%) in Q1, while the y/y rate plunged to -1.4% vs. -0.2% expected and a revised -3.9% (was -4.0%) in Q1. June retail sales data will be reported Tuesday, with volume expected at -2.0% y/y vs. -4.9% in May. The economy is being directly impacted by the slowdown on the mainland as well as higher interest rates required under the HKD peg. Liquidity has been tightening due to HKMA intervention to defend the peg, which has driven HIBOR higher. Commercial banks have kept their prime rates steady despite 225 bp of Fed tightening but will have to eventually raise them as well. With the peg remaining under pressure, we see tighter liquidity continuing to weigh on the economy in the coming months. However, we believe the peg will remain intact for the reasons stated here.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2022. All rights reserved.