Dollar Firm Ahead of Jobs Report

August 04, 2023

Win Thin

U.S. yields remain elevated at the long end of the curve; the July jobs report will be the highlight; July ISM services PMI was on the soft side; Canada highlight will also be July jobs data
BOE hiked rates 25 bp to 5.25%, as expected; Bailey’s press conference was inconsistent; Germany reported strong June factory orders; eurozone reported soft June retail sales; France, Spain, and Italy all reported June IP
Japan’s GPIF posted a whopping 9.5% return in Q2; RBA released its Statement on Monetary Policy that contained new macro forecasts

The dollar remains firm ahead of the jobs report. DXY is trading slightly higher near 102.564 and remains on track to test the July high near 103.572. The euro is trading lower near $1.0940 and remains on track to test the July low near $1.0835. Sterling is trading lower near $1.27 and remains on track to test the late June low near $1.2590. USD/JPY is trading higher near 142.75 and remains on track to test the June 30 high near 145. We believe the relative fundamental story should continue to move in favor of the greenback. As we expected, the FOMC, ECB, and BOJ decisions last week as well as the economic data this week underscore the divergence theme and so further dollar gains seem likely.

AMERICAS

U.S. yields remain elevated at the long end of the curve. The 10-year yield is trading at the highest since November near 4.20%. Next up is that month's high near 4.24% and then the October cycle high near 4.34%. As we recounted earlier this week, it has been 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. remain strong. On their own, each of these drivers might have had a marginally negative impact on bonds but taken together, the floodgates opened. We believe these drivers of higher yields are likely to remain in play for the foreseeable future.

The July jobs report will be the highlight. Consensus has crept higher to stand at 200k vs. 209k in June, while the unemployment rate is expected to remain steady at 3.6%. Average hourly earnings are expected to ease a couple of ticks to 4.2% y/y. Despite the ADP’s huge miss last month, it still seems to have an impact on market expectations as Bloomberg’s whisper number has risen to 223k vs. 200k at the start of this week. Other indicators suggest the labor market remains firm and so we see upside risks to today’s numbers.

The Fed outlook remains totally data-dependent, as it should. WIRP suggests odds of a hike September 20 are around 20% but we think this should be much higher. Those odds top out near 40% November 1 but should move higher if the data remain firm. Stay tuned.

July ISM services PMI was on the soft side. Headline came in at 52.7 vs. 53.1 expected and 53.9 in June. The details were mixed, as employment came in at 50.7 vs. 53.1 in June, activity came in at 57.1 vs. 59.2 in June, and prices paid came in at 56.8 vs. 54.1 in June. Prices paid also rose in the ISM manufacturing report and suggest some upside risks for CPI and PPI next week. Despite the modest downside miss in the headline, the economy seems to be humming along so far in H2.

Canada highlight will also be July jobs data. Consensus sees 25.0k jobs added vs. 59.9k in June, while the unemployment rate is expected to rise a tick to 5.5%. Ivey PMI will also be reported today. Real sector data have remained firm but inflation eased more than expected in June and so the Bank of Canada outlook remains in flux. WIRP suggests 33% odds of a hike September 6, rising to 55% October 15 and 66% December 6.

EUROPE/MIDDLE EAST/AFRICA

Bank of England hiked rates 25 bp to 5.25%, as expected. Haskel and Mann voted for a 50 bp hike while Dhingra voted for no change, but the split decision shouldn’t come as a huge surprise. The bank left the door wide open for further hikes and stressed that rates would remain “sufficiently restrictive for sufficiently long” until inflation is brought back to target. However, we believe the updated forecasts were unrealistic and quite frankly inconsistent. At the heart of the matter is the growth outlook. The bank said that it’s not forecasting a recession but admitted that the risks of one are “significant.” Despite modest growth forecast for this year through 2025, unemployment is seen rising and inflation is seen falling. Indeed, the bank sees inflation just below 5% by year end and below the 2% target by Q2 2025. We simply don't think inflation can fall that quickly without a deep recession.

Bailey’s press conference was similarly inconsistent. He said inflation risks remain skewed to the upside but then said he sees inflation below target by the end of the forecast period in 2025. He note that the labor market remains strong and that wage growth is “materially stronger” than in May, but added that there are signs the labor market is loosening. Bottom line: this rosy outlook seems to be based more on wishful thinking than on reality. Looking ahead, WIRP suggests 25 bp hikes September 21 and December 14 are priced in, with some odds of a third hike that top out near 35% in Q1. This would see the bank rate peak near 5.75% vs. 6.5% at the start of last month. However, the swaps market sees the rate staying at 5.75% over the next twelve months before rate cuts begin in the subsequent twelve months as Bailey said it was “far too soon to speculate on when we might see a cut.” Chief Economist Pill speaks today.

Germany reported strong June factory orders. They were expected at -2.0% m/m but instead jumped 7.0% vs. a revised 6.2% (was 6.4%) in May. The y/y improved to 3.0% and was the first positive reading since February 2022. We can’t get excited about this reading as virtually all other indicators suggest Germany is slipping into recession.

Eurozone reported soft June retail sales. Sales came in at -0.3% m/m vs. 0.2% expected and a revised 0.6% (was 0.0%) in May.

France, Spain, and Italy all reported June IP. France came in at -0.9% m/m vs. -0.3% expected and a revised 1.1% (was 1.2%) in May, Spain came in at -1.0% m/m vs. -0.5% expected and a revised 0.5% (was 0.6%) in May, and Italy came in at 0.5% m/m vs. -0.3% expected and a revised 1.7% (was 1.6%) in May. Germany reports IP August 7 (-0.4% m/m expected) while eurozone reports August 16.

Market expectations for ECB policy remain subdued. WIRP suggest odds of a 25 bp hike stand near 35% 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.

ASIA

Japan’s Government Pension Investment Fund posted a whopping 9.5% return in Q2. Total assets rose JPY18.98 trln to a record JPY219.17 trln yen. Domestic stocks gained 14.4% while overseas stocks rose 15.4%. Local fixed income gained 0.4% while overseas bonds gained 8.1%. GPIF head Masataka Miyazono warned “The big profit is just a short-term result. According to our model, gains of 9.49% should appear only once in nine years. We continue to fulfill our duty by making long-term investments.” Of note, half of the GPIF portfolio is in fixed income and so Q3 returns will be impacted by the current global bond market selloff after the BOJ tweaked YCC. Yen-based global equity market returns have been mixed so far in Q3 and may not be enough to offset the bond losses.

Reserve Bank of Australia released its Statement on Monetary Policy that contained new macro forecasts. The inflation forecast for end-2023 was revised down slightly while it was revised up slightly for end-2024. However, inflation is now forecast to reach the 2-3% target range at end-2025 vs. mid-2025 previously and suggests rates will remain higher for longer. The bank noted that “The board’s current assessment is that the risks around the inflation outlook are broadly balanced. But it recognizes that the crystallization of upside risks would increase the likelihood of inflation staying high for longer and a rise in medium-term inflation expectations.” RBA tightening expectations remain subdued. Next policy meeting is September 5 and WIRP suggests no odds of a 25 bp hike then. Those odds slowly rise thereafter and top out near 50% in Q1.

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