Dollar Soft Ahead of CPI Data

September 13, 2022

Win Thin

U.S. yields continue to rise; Fed tightening expectations remain elevated; U.S. inflation data take center stage; demand for USTs appears to be softening
German September ZEW survey weakened further; ECB tightening expectations remain elevated; the monthly U.K. data dump continues
Japan reported August PPI

The dollar remains under pressure ahead of the CPI data. After trading at a new cycle high Wednesday near 110.786, DXY is down for the fifth straight day and trading just below 108. The next target is the August 26 low near 107.588 but a break below 107 would signal a deeper correction to the August 10 low near 104.636. The euro has led the recovery in the foreign currencies and traded as high as $1.02 yesterday. A clean break above would set up a test of the August 10 high near $1.0370. Sterling also bounced after testing the March 2020 low near $1.1410 last week but is lagging the euro and is currently trading near $1.1710. As a result, the EUR/GBP cross traded at a new high for this move near 0.8720 yesterday before falling back below 0.8700. USD/JPY traded as low as 141.50 last week and despite a modest recovery, the pair is trading heavy near 142 currently. We view this current dollar sell-off as corrective in nature and maintain our strong dollar call. In our view, nothing has really changed fundamentally and the global backdrop continues to favor the dollar and U.S. assets in general.

AMERICAS

U.S. yields continue to rise. The 2-year yield traded at a new cycle high near 3.58% yesterday, while the 10-year yield traded near 3.38%, slightly above last week’s high near 3.36% and within sight of the June 14 high near 3.50%. Both have fallen slightly today. Of note, the real 10-year yield hit 0.94% yesterday, the highest since January 2019. This is due both to rising nominal yields as well as falling inflation expectations. For now, the market is giving the Fed a thumbs up in terms of its aggressive tightening.

Fed tightening expectations remain elevated. WIRP suggests 90% odds of a 75 bp hike September 21, while the swaps market continues to price in a terminal rate near 4.0%. If the market gives the Fed 75, it will take it. There are no Fed speakers this week as the media blackout went into effect midnight Friday. It remains in place until Chair Powell’s post-decision press conference on September 21.

U.S. inflation data take center stage. August CPI will be reported today and headline is expected at 8.1% y/y vs. 8.5% in July, while core is expected at 6.1% y/y vs. 5.9% in July. If so, headline would decelerate for the second straight month from the 9.1% peak in June to the lowest since February. PPI will be reported tomorrow. Headline is expected at 8.8% y/y vs. 9.8% in July, while core is expected at 7.1% y/y vs. 7.6% in July. Even if there are downside surprises in the data, the Fed has made it clear that it will not react to one or two months of good inflation data and so the impact of these readings on the September 20-21 FOMC meeting will be negligible. August budget statement also will be reported and is expected at -$217.0 bln vs. -$211.1 bln in July.

Demand for U.S. Treasuries appears to be softening. Yesterday, Treasury saw weak demand as it sold $41 bln of 3-year notes and $32 bln of 10-year notes. The bid/cover ratios fell to 2.49 and 2.37 vs. 2.50 and 2.53 at the previous auctions, respectively. Similarly, indirect bidders took 54.5% and 62.3% vs. 63.1% and 74.5% at the previous auctions, respectively. Today, Treasury sells $18 bln of 30-year bonds. At the previous auction, the bid/cover ratio was 2.31 and indirect bidders took 70.6%.

EUROPE/MIDDLE EAST/AFRICA

German September ZEW survey weakened further. Expectations came in at -61.9 vs. -59.5 expected and -55.3 in August, while current situation came in at -60.5 vs. -52.1 expected and -47.6 in August. Germany remains the weak link in the eurozone and the data are expected to continue weakening as we go into autumn and winter.

ECB tightening expectations remain elevated. WIRP suggests 60% odds of another 75 bp hike October 27, down from being fully priced in right after last Thursday’s ECB meeting. Looking ahead, the swaps market is priding in nearly 250 bp of tightening over the next 12 months that would see the deposit rate peak near 3.25%. Can the ECB really tighten that much when much of the eurozone is already tipping into recession? We know that the ECB has a single mandate for inflation but we remain skeptical that rates will rise that much. Stay tuned.

The monthly U.K. data dump continues. Labor market data came in firm. Payrolled employees rose 71kin August vs. 60k expected and a revised 77k (was 73k) in July. Average weekly earning rose 5.5% for the three month period ending in July vs. a revised 5.2% (was 5.1%) previously, while the unemployment rate fell two ticks to 3.6% as employment rose 40k during that same period. This is the lowest unemployment rate since 1974 and suggests upward pressure on wages will continue. In turn, this will keep pressure on the Bank of England to continue tightening.

The Bank of England meeting was moved to next Thursday due to the Queen’s passing. WIRP suggests a 75 bp hike is nearly 70% priced in, down from nearly 85% at the start of last week. Looking ahead, the swaps market is pricing in 250 bp of tightening over the next 12 months that would see the policy rate peak near 4.25%, down from 4.5% at the start of last week. Last week’s BOE testimony before Parliament was decidedly tepid, bringing into question the bank’s ability to tighten policy as aggressively as the market is pricing.

ASIA

Japan reported August PPI. PPI came in at 9.0% y/y vs. 8.9% expected and a revised 9.0% (was 8.6%) in July. While it remains elevated, PPI inflation appears to have peaked and suggests the same will be seen for the various CPI measures. The Bank of Japan meeting September 21-22 has taken on a bit less importance with USD/JPY trading well off the highs. While we expect this pair to resume its climb, markets may be reluctant to sell the yen ahead of that BOJ meeting on the off chance (very unlikely) that the bank does do some sort of pivot this month.

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