• The dollar rally has been interrupted by developments out of Asia; recent data suggest a pause is warranted by the Fed next week; U.S. financial conditions continue to loosen
  
• The EC cut its outlook for eurozone growth; the new forecasts come ahead of the ECB meeting Thursday; Italy reported weak July IP; Norway reported soft August CPI; Czech Republic reported August CPI
  
• The yen gained today after comments from BOJ Governor Ueda; Japan reported weak August machine tool orders; the yuan gained today after comments from the PBOC; China reported August money and loan data

The dollar is starting this week on its back foot due to developments in Asia. We do not think the dollar uptrend has ended and believe it’s very dangerous to short it ahead of key data later this week. DXY is trading lower near 104.688 after seven straight up days and remains on track to test to March high near 105.883. USD/JPY is the big mover after Ueda comments (see below) and traded as low as 145.90 before recovering to trade back near 147. The euro is trading higher near $1.0735 while sterling is trading higher near $1.2515. Despite the recent softish U.S. data, we believe the fundamental story remains in favor of the greenback. We do not think the foreign currencies can maintain these gains. Looking through the noise, the U.S. remains in a much stronger position than the other major economies such as the eurozone or the U.K. Data this week should confirm our outlook and lead to resumed dollar strength.

AMERICAS

The dollar rally has been interrupted by developments out of Asia. Policymakers from Japan and China made comments that led to some profit-taking in long dollar positions but we do not think the uptrend has been derailed (see below). As long as monetary policy divergences remains in play, the dollar should continue to gain.

Recent data suggest a pause is warranted by the Fed next week. WIRP suggests only 5% odds of a hike September 20. More likely, we will see the next hike November 1. By that November meeting, we will get one more jobs report and two each of CPI, PPI, retail sales, and PCE. If things go the way we expect for the U.S., the current 45% odds of a hike then are too low. There are no Fed speakers this week due to the media embargo.

U.S. financial conditions continue to loosen. The Chicago Fed’s weekly financial conditions index are the loosest since early February, well before the Fed started hiking rates on March 16. Let that sink in. And then realize that the Fed has to do more in order to rein in the red hot US economy. How hot? The Atlanta Fed's GDPNow model is now tracking Q3 growth at 5.6% SAAR. Next model update comes next Thursday after the data.

EUROPE/MIDDLE EAST/AFRICA

The European Commission cut its outlook for eurozone growth. Growth is now forecast at 0.8% this year vs. 1.1% previously and forecast at 1.3% next year vs. 1.6% previously. Germany remains the weak link and is expected to contract -0.4% this year. Elsewhere, eurozone inflation is now forecast at 5.6% this year vs. 5.8% previously and forecast at 2.9% next year vs. 2.8% previously. The EC noted that "Monetary tightening may weigh on economic activity more heavily than expected, but could also lead to a faster decline in inflation that would accelerate the restoration of real incomes."

The new forecasts come ahead of the European Central Bank meeting Thursday. Of the 55 analysts polled by Bloomberg, 30 see no change and 25 see a 25 bp hike to 4.0%. Similarly, WIRP suggest odds of a 25 bp hike stand near 40% but rise to 60% October 26 and top out near 70% December 14. These odds will rise and fall with the data but what’s very interesting to us is that the ECB is likely to stop hiking before the Fed does. If so, it would be a game-changer for the euro. Updated macro forecasts will also be released Thursday. We expect growth forecasts to be revised down and inflation forecasts to be revised up, similar to what we saw with the EC.

Italy reported weak July IP. IP came in at -0.7% m/m vs. -0.3% expected and 0.5% in June, while the y/y rate came in at -2.1% vs. -1.8% expected and a revised -0.7% (was -0.8%) in June. Eurozone reports July IP Wednesday and is expected at -0.8% m/m vs. 0.5% in June, while the y/y rate is expected at -0.3% vs. -1.2% in June.

Norway reported soft August CPI. Headline came in at 4.8% y/y vs. 5.4% expected and actual in July, while underlying came in at 6.3% y/y vs. 6.6% expected and 6.4% in July. Headline is the lowest since March 2022 but still well above the 2% target. At the last policy meeting August 17, Norges Bank hiked rates 25 bp to 4.0% and said rates “will most likely be raised further in September” but gave no further forward guidance. We take Norges Bank at its word and look for a hike at the September 21 meeting, but it will be a very close call. The swaps market sees a peak policy rate near 4.25% over the next six months.

Czech Republic reported August CPI. Headline came in as expected at 8.5% y/y vs. 8.8% in July. It is the lowest since December 2021 but still well above the 1-3% target range. Next central bank policy meeting is September 27 and after Poland delivered a dovish surprise last week, we believe Czech National Bank may follow suit and start the easing cycle then. The market is pricing in 75 bp of easing over the next three months followed by another 50 bp over the subsequent three months.

ASIA

The yen gained today after comments from BOJ Governor Ueda. He wasn’t exactly hawkish but markets took it that way. Specifically, Ueda said the bank might have enough data by year-end to know whether wages will continue to rise, which has become a major condition for removing stimulus. He stressed that the BOJ is still some way from achieving its price stability target but if it becomes confident that prices and wages will keep rising sustainably, ending negative interest rates is among the options available. Note that he did not say he thinks wages will rise enough to warrant tightening, just that the bank will know more by year-end. Sounds very data dependent to us and we note that the wage data has been very disappointing. July cash earnings data came in weaker than expected and August won’t be reported until October 6.

Until the BOJ actually tightens, we do not think this bounce in the yen can be sustained. And judging by recent data out of Japan, the economy is showing signs of slowing, with the labor market softening as a result. As such, we see no change at the next policy meeting September 21-22. Jawboning and FX intervention can slow the move but as long as monetary policy divergences remain, further weakness in the yen is likely.

Japan reported weak August machine tool orders. Total orders came in at -17.6% y/y vs. -19.7% in July. However, weakness was driven by domestic orders (-31.1% y/y) rather than foreign (-9.7% y/y). July core machine orders will be reported Thursday and are expected at -10.3% y/y vs. -5.8% in June. Orders have been weakening all year and we expect that trend to continue.

The yuan gained today after comments from the PBOC. The bank warned that policymakers in China will take action to correct one-sided moves in the FX market as needed, adding that they are confident that actions would keep the yuan basically stable. Specifically, it said “Participants of the foreign exchange market should voluntarily maintain a stable market,” adding that they should “resolutely avoid behaviors that disturb market orders such as conducting speculative trades.” Jawboning and intervention can slow the move but similar to what we wrote about Japan’s situation, as long as monetary policy divergences remain, further weakness in the yuan is likely.

China reported August money and loan data. New loans came in at CNY1.36 trln vs. CNY1.25 trln expected and CNY346 bln in July, while aggregate financing came in at CNY3.12 trln vs. CNY2.69 trln expected and CNY528 bln in July. The slight uptick reflects recent piecemeal efforts to boost lending. PBOC sets its key 1-year MLF rate Friday and is expected to remain steady at 2.5% after cutting it 15 bp in August.