Dollar Gets Some Traction as New Week Begins

July 10, 2023

Win Thin

Markets are still digesting last week’s jobs report; only minor data will be reported today
U.K. Chancellor Hunt will give his annual Mansion House speech; BOE tightening expectations remain elevated; Norway reported mixed June CPI data; Riksbank released minutes from its June 28 meeting; Israel is expected to keep rates steady at 4.75%.
Japan reported May current account data; there’s a changing of the guard Down Under; China has a deflation problem

The dollar is getting some traction in the wake of the jobs report. DXY is trading slightly higher near 102.38 after two straight down days. Both U.S. yields and the dollar are off last week’s highs as the jobs data showed some signs of cooling (see below). Odds of a second Fed hike are still around 40% and so we’d look to fade this current bout of dollar weakness. The euro is trading flat near $1.0960 while sterling is trading lower near $1.28. USD/JPY remains heavy after being unable to break above 145 but saw support emerge near 142 and is currently trading near 142.60. With the jobs report in the rear view mirror, markets need to start focusing on this week’s CPI and PPI data. Markets are still seeing significant risks of a second Fed hike this year (see below). The inflation data will be key to further repricing of Fed policy and we view current dollar softness as a gift to dollar bulls.

AMERICAS

Markets are still digesting last week’s jobs report. While the headline NFP reading of 209k was lower than expected and the previous two months were revised down by a cumulative -110k, we believe the details were firm. Average hourly earnings came in higher than expected at 4.4% y/y, as did the average workweek at 34.4 hours. The unemployment rate fell to 3.6% and is hovering near the cycle low of 3.4% from January. Taken in conjunction with other indicators, the labor market remains relatively tight and underscores the need for further tightening. We believe a 25 bp hike this month is a done deal. Indeed, WIRP suggests a 25 bp hike is largely priced in, while the odds of a second 25 bp hike this year are still hovering around 40%. However, the first rate cut has been pushed forward to next June vs, next July at the start of last week. Barr, Daly, Mester, and Bostic speak today.

Only minor data will be reported today. May consumer credit and wholesale inventories and trade sales will be reported but the bottom line is that the U.S. economy remains fairly robust as we move into H2. Yes, there are some pockets of softness but the economy continues grow near trend at a time when the Fed is seeking below trend growth. The Atlanta Fed’s GDPNow model is currently tracking 2.1% SAAR in Q2. The next model update comes today after the data.

EUROPE/MIDDLE EAST/AFRICA

U.K. Chancellor Hunt will give his annual Mansion House speech. Reports suggest he will propose several changes that are meant to boost the attractiveness of U.K. financial services. Hunt is also expected to announce several pension reforms, with the most noteworthy being a push for firms to invest 5% of their defined contribution funds into areas such as life sciences and technology by 2030. Hunt said last week that “These commonsense changes are grasping our newfound Brexit freedoms to simplify the rulebook, making it easier than ever for firms to research, raise funds, and float their business.”

BOE tightening expectations remain elevated. WIRP suggests another 50 bp hike is largely priced August 3, followed by another 50 bp hike September 21. After that, 25 bp hikes are priced in for Q4 and Q1 that would see the bank rate peak near 6.5% vs. 6.25% at the start of last week. This would represent the most aggressive tightening cycle in the majors so far in terms of absolute magnitude and yet the benefits to sterling of a higher BOE rate path are starting to wane. That’s because a recession is now back on the table after some earlier optimism that one might be avoided. Updated macro forecasts will come at the August meeting and will have to acknowledge the worsening backdrop. Bailey speaks later today.

ECB tightening expectations are edging higher. WIRP suggests a 25 bp hike is nearly priced in July 27, as is another 25 bp hike in Q4. Odds of a third hike have risen to around 20% vs. zero odds at the start of last week. However, we are not yet convinced the bank will continue hiking with the eurozone already tipping into recession. Herodotou and Nagel speak later today.

Norway reported mixed June CPI data. Headline came in as expected at 6.4% y/y vs. 6.7% in May, while underlying came in at 7.0% y/y vs. 6.6% expected and 6.7% in May. Headline remains well above the 2% target and the fourth straight month of acceleration in underlying is even more concerning. At the last meeting June 22, Norges Bank delivered a hawkish surprise and hiked rates 50 bp to 3.75% vs. 25 bp expected and said rate will “most likely be raised further in August.” Updated macro forecasts were released and the expected rate path was shifted higher to a peak of 4.25% this year. Next meeting is August 17 and a 25 bp hike is expected then. However, if July CPI runs hot, we think a 50 bp hike will be on the table. The swaps market is now pricing in a peak policy rate between 4.25-4.50% over the next six months vs. 4.25% at the start of last week.

Riksbank released minutes from its June 28 meeting. At that meeting, it hiked rates 25 bp to 3.75% and said rates would be hiked at least one more time this year, with minutes showing increased concerns about the impact of the weak krona. First Deputy Governor Anna Breman said “The depreciation of the krona is problematic. We have no target for the krona but the long trend of a weak krona is counteracting a decline in inflation. Imported goods and food may become more expensive but there are also more indirect effects that may be important in the current situation.” Elsewhere, Governor Thedeen said “If it turns out that the krona’s depreciation this past year has a greater pass-through to inflation than we have previously assumed, it may, all else equal, lead to a tighter monetary policy than is now projected in our rate path.” Since that decision, the krona has weakened nearly 1.5% as EUR/SEK traded at a new record high last week near 11.95 before falling back slightly this week. The swaps market sees around 85% odds of a 25 bp hike at the next meeting September 21 but fully priced in for November 23. Looking ahead, the market sees another 25 bp hike in Q4 that would see the policy rate peak near 4.25%. We expect that peak to rise if inflation remains stubbornly high. Sweden reports June CPI Friday.

Bank of Israel is expected to keep rates steady at 4.75%. However, a few analysts polled by Bloomberg look for a 25 bp hike to 5.0%. At the last meeting May 22, the bank hiked rates 25 bp and said politics have forced it to hike more than it planned due to shekel weakness. Since that meeting, the shekel has weakened around 1.5% but remains vulnerable as protests are intensifying again after Prime Minister Netanyahu said he would continue his efforts to push through controversial judicial reforms. June CPI will be reported Friday and headline is expected to fall two ticks to 4.4% y/y. If so, it would continue the deceleration from the 5.4% peak in January to the lowest since June 2022.

ASIA

Japan reported May current account data. The adjusted surplus came in at JPY1.7 trln vs. JPY1.87 trln expected and JPY1.9 trln in April. However, the investment flows will be of more interest. The May data showed that Japan investors were net buyers of U.S. bonds (JPY3.0 trln) again and for four of the past five months. Japan investors remained net buyers (JPY213 bln) of Australian bonds for the third straight month after eight straight months of net selling, and also remained net sellers of Canadian bonds (-JPY32 bln) for the fifth straight month and for fifteen of the past sixteen months. Investors turned net sellers of Italian bonds (-JPY271 bln) after two months of net buying. Overall, Japan investors were total net buyers of foreign bonds (JPY3.16 trln) again and for four of the past five months. With signs growing that the BOJ is on hold for now, we expect investors to continue chasing higher yields abroad and that’s negative for the yen.

There’s a changing of the guard Down Under. Westpac Chief Economist Bill Evans will step down from his role at the bank after more than 30 years and will be replaced by current Reserve Bank of Australia Assistant Governor Luci Ellis. The RBA confirmed her departure and Westpac said she will begin her new position October 9. Evans will remain on at Westpac as a senior economic advisor starting January 2024. Making things even more interesting, the moves come as Treasurer Jim Chalmers is in the process of selecting the next RBA chief when current Governor Lowe’s term ends this September. Other senior RBA officials have left in recent months, including former Deputy Governor Guy Debelle last year, which leaves fewer experienced hands at the central bank during very uncertain times. This may work in current Governor Lowe’s favor. In terms of policy, WIRP suggests two 25 bp hikes are priced in by year-end.

China has a deflation problem. June CPI and PPI came in soft. CPI came in flat y/y vs. 0.2% expected and actual in May while PPI came in at -5.4% y/y vs. -5.0% expected and -4.6% in May. Overall, recent mainland data warn of a deflationary spiral ahead if policymakers do not take aggressive action. For now, we are only seeing very modest measures. Yet policymakers cannot rely on the usual levers of stimulus due to an already high debt overhang. There’s simply no easy way out. Of note, China reports June money and loan data sometime this week. New loans are expected at CNY2.3 trln vs. CNY1.36 trln in May and aggregate financing is expected at CNY3.05 trln vs. CNY1.56 trln in May.

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