• Fitch downgraded its sovereign rating for the US to AA+; the U.S. economy remains firm; ADP report will be the highlight; June JOLTS job openings suggest some cooling in the labor market; Brazil is expected to cut rates 25 bp to 13.5%
  
• BOE appointed Sarah Breeden as Deputy Governor for financial stability; the news comes ahead of the BOE decision tomorrow
  
• BOJ released minutes of its June 15-16 meeting; if the minutes had been released a week earlier, the markets would not have been caught off guard by the surprise tweak; New Zealand reported soft Q2 labor market data; CALSTRS reported that China has fallen out of its top twelve country holdings; Thailand hiked rates 25 bp to 2.25%, as expected

The dollar is shrugging off the unexpected Fitch downgrade. DXY is trading flat near 102.277 after two straight up days. Clean break above key level near 102.046 sets up a test of the July high near 103.572. The euro is trading lower near $1.0975 and clean break below $1.10 sets up a test of the July low near $1.0835. Sterling is trading flat near $1.2785 and clean break below $1.28 sets up a test of the late June low near $1.2590. The yen is outperforming as USD/JPY trades lower near 142.75 after trading as high 143.55 yesterday. Clean break above 142 sets up a test of the June 30 high near 145. We disagree with the Fitch downgrade (see below) and believe the relative fundamental story should continue to shift back in favor of the greenback. As we expected, the FOMC, ECB, and BOJ decisions last week as well as the economic data underscore the divergence theme and so further dollar gains seem likely.

AMERICAS

Fitch downgraded its sovereign rating for the United States to AA+ from AAA previously. The outlook was moved to stable from “watch negative.” The agency noted that “The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.” Fitch said “Additionally, there has been only limited progress in tackling medium-term challenges related to rising social security and Medicare costs due to an aging population” and added that “Fitch forecasts a GG (General Government) deficit of 6.6% of GDP in 2024 and a further widening to 6.9% of GDP in 2025.”

While Fitch has had the U.S. on watch negative since May, the timing was nevertheless surprising. The debt ceiling impasse has been kicked down the road and so there are limited fiscal risks until early 2025, when the next debt ceiling dance begins. The last time Fitch put the U.S. on “watch negative” was in October 2013 but the agency then put the rating back to stable in March 2014 without any rating downgrade. The only time that the U.S. was actually downgraded was back in August 2011, during particularly contentious debt ceiling negotiations that threatened default. We and many others disagree with the downgrade but here we are. Moody’s is now the only major rating agency to have the U.S. at Aaa and that is simply wrong. U.S. Treasury yields are little changed since the Fitch downgrade and so the markets seem to agree with us.

The Fed outlook remains totally data-dependent, as it should. WIRP suggests odds of a hike September 20 are around 15% but we think this should be much higher. That FOMC meeting seems far off and so much can happen between now and then. In terms of data, we get two each of jobs, CPI, and PPI and one PCE reading before the decision. In between the July and August data reports, the Jackson Hole symposium will be held and we may get an early read on the September FOMC. From the Kansas City Fed's website: The 2023 Economic Policy Symposium. “Structural Shifts in the Global Economy,” will be held Aug. 24-26.

The U.S. economy remains firm. How firm? After posting 2.4% SAAR growth in Q2, the Atlanta Fed’s GDPNow estimate for Q3 is now 3.9% SAAR vs. the initial 3.5% reading. This can't be sustained and there will be significant revisions as the data come in. For instance, the Atlanta Fed’s initial estimate for Q2 was 1.66% SAAR on April 28 and ranged between 1.64% and 2.89% before ending at 2.41% last week and lining up perfectly with the official Q2 reading. Still, it suggests that strong momentum is carrying over into Q3 and that we are likely to see another quarter of growth at or above trend. Next model update will be next Tuesday. Current Bloomberg consensus for Q3 is 1.5% SAAR.

ADP report will be the highlight. Its private sector jobs estimate is expected at 190k vs. 497k in June. That said, the report is likely to have very little impact in either direction given its huge miss last month. Consensus for NFP 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.

June JOLTS job openings suggest some cooling in the labor market. Openings came in at 9.582 mln vs. 9.60 mln expected and 9.824 mln in May. This was the lowest since April 2021 and while this suggests some softness in the labor market, openings are still well above "normal" pre-pandemic levels. Elsewhere, hires fell to 5.905 mln, the lowest since February 2021, while layoffs also fell to 1.527 mln, the lowest since December, suggesting employers remain reluctant to let go of workers.

July ISM manufacturing PMI was reported. Headline came in at 46.4 vs. 46.9 expected and 46.0 in June. Employment came in at 44.4 vs. 48.1 in June and new orders came in at 47.3 vs. 45.6 in June. Of note, supplier deliveries rose to 46.1 vs. 45.7 in June while backlog of orders rose to 42.8 vs. 38.7 in June. Both have risen two straight months and the higher these numbers are, the higher the strains in the supply chains. If both these measures continue to rise, this is obviously not a good sign for inflation going forward and could boost the prices paid component further after it rose to 42.6 vs. 41.8 in June. The details were mixed but either way, weak manufacturing is a global phenomenon and so let's look ahead to the more important ISM services PMI Thursday, where the headline expected at 53.0 vs. 53.9 in June. Keep an eye on employment and prices paid, which stood at 53.1 and 54.1 in June, respectively.

Brazil COPOM is expected to cut rates 25 bp to 13.5%. However, about a quarter of the analysts polled by Bloomberg see a 50 bp move. The swaps market is pricing in 125 bp of total easing over the next three months followed by another 125 bp over the subsequent three months. Forward guidance will be key. With fiscal policy still expansive, we suspect the central bank will be very cautious in its easing cycle. Of note, the 12-month primary balance equal to -0.24% of GDP in June was the first deficit since October 2021, while the 12-month nominal deficit equal to -6.42% of GDP was the biggest since July 2021.

EUROPE/MIDDLE EAST/AFRICA

Bank of England appointed Sarah Breeden as Deputy Governor for financial stability. She is currently at the bank serving as executive director for financial stability strategy and risk. Breeden will begin her five-year term beginning November 1 and will succeed outgoing Jon Cunliffe. This is just one day before the November 2 decision. The MPC holds four meetings (pre-meeting, first meeting, second meeting, and final meeting) in the week leading up to the decision to discuss recent data, debate policy, and then vote on policy before announcing its decision on Thursday. As such, it’s not clear to us how involved Breeden will be in that month’s decision.

The news comes ahead of the BOE decision tomorrow. The bank is expected to hike rates 25 bp to 5.25%. WIRP suggests odds of a 50 bp hike have fallen to 30% after being largely priced in at the start of last month. Looking ahead, 25 bp hikes September 21 and November 2 are priced in, while odds of one last 25 bp hike top out near 35% in Q1. This lower expected rate path would see the bank rate peak near 5.75% vs. 6.5% at the start of the month. This is a huge downward adjustment that is taking a toll on sterling. Updated macro forecasts will be released and we expect upward revisions for inflation and downward revisions for growth.

ASIA

The Bank of Japan released minutes of its June 15-16 meeting. It seems that the board members had serious discussions about tweaking its Yield Curve Control then but ultimately decided not to, instead doing so at last week’s meeting. One member noted that “In conducting Yield Curve Control, it’s necessary to avoid a surge in interest rates as much as possible when speculation over an exit from monetary easing grows.” Other board members said the bank needs to consider the risks of unintended shifts in market expectations for monetary tightening if YCC were tweaked. In the end, the board decided there was no need to make adjustments to YCC at that point given the shape of the yield curve and the improvement seen in the functioning of the bond market.

If the minutes had been released a week earlier, the markets would not have been caught off guard by the surprise tweak. What really changed between the June and July meetings? The extra-dovish statements that accompanied the tweak were clearly meant to address those concerns that the markets would start to price in liftoff prematurely. Yet markets are still puzzled by the move and so the summary of opinions to last week’s meeting out next week will be very interesting, to state the obvious. The more detailed minutes won’t be published until after the September 21-22 meeting.

New Zealand reported soft Q2 labor market data. Unemployment came in at 3.6% vs. 3.5% expected and 3.4% in Q1. This was the highest since Q2 2012. Both wages including and excluding overtime came in at 1.1% q/q vs. 1.2% expected and 0.9% in Q1, while the y/y rates for both eased to 4.3% vs. 4.5% in Q1. Elsewhere, average hourly earnings came in at 1.9% q/q vs. 2.1% in Q1, while the y/y rate eased to 7.7% vs. 8.2% in Q1. The data have been coming in soft lately and support the RBNZ’s decision to end its tightening cycle. Next policy meeting is August 16 and WIRP suggests around 5% odds of a hike. Those odds rise to around 15% October 4 and top out near 45% November 29. If data remain soft, we believe the tightening cycle has indeed ended.

California State Teachers’ Retirement System reported that China has fallen out of its top twelve country holdings. CALSTRS reported that at the end of May, its allocation to China trailed Korea, India, Mexico and Ireland (and many others) and that China’s weight in its overall investment portfolio fell from 2.1% at the end of 2020. However, the latest percentage share was not disclosed. As the world’s second largest economy, having a country weighting smaller than Korea and Mexico (both a tenth of its size) is noteworthy. We believe this has been driven largely by China’s unpredictable crackdowns on its tech sector, an adherence to Covid Zero policies long after the rest of the world reopened, a deteriorating macro outlook, and President Xi’s generally inward-looking policies. The flows could return in the coming years but it will depend on how Xi responds to the mounting economic and demographic challenges.

Bank of Thailand hiked rates 25 bp to 2.25%, as expected. However, it signaled that the cycle in nearing an end as it dropped its reference to the need for “gradual and measured” rate hikes going forward. Assistant Governor Piti also noted that overall financial conditions have turned less accommodative. The swaps market is pricing in one last hike to 2.5% over the next three months. Elsewhere, the Thaksin-linked Pheu Thai party is trying to break the political stalemate by announcing it will try to form a coalition without the Move Forward party. Conservative parties backed by the military have successfully blocked two attempts at forming a government with Move Forward, the party holding the most seats.