Dollar Soft Ahead of FOMC Decision

July 26, 2023

Win Thin

The two-day FOMC meeting ends with an expected 25 bp hike; the dollar tends to weaken on FOMC decision days; housing sector data will remain in focus; consumer confidence remains high; BOC releases the summary of its deliberations
Eurozone M3 data came in soft for June; the two-day ECB meeting begins today and ends tomorrow with an expected 25 bp hike; junior doctors in the U.K. will strike for four days next month; BOE tightening expectations remain subdued
Markets are getting a bit more concerned about a surprise from the BOJ; Australia reported soft June and Q2 CPI data; China appointed Pan Gongsheng as the new PBOC Governor

The dollar is soft ahead of the FOMC decision. The dollar tends to weaken on FOMC decision days (see below) and today is no exception. DXY is trading lower near 101.134 after six straight up days. The euro is trading higher near $1.1080 while sterling is trading higher near $1.2915. USD/JPY is trading lower near 140.40 as markets get defensive for a surprise from the BOJ this Friday (see below). We believe a hold from the BOJ will trigger a move higher in this pair. AUD is the worst performing major today after soft CPI data overnight (see below). We had been frustrated with recent dollar weakness but the relative fundamental story seems to be shifting back in favor of the greenback. The FOMC, ECB, and BOJ decisions this week are widely expected to underscore the divergence theme and so further dollar gains seem likely.

AMERICAS

The two-day FOMC meeting ends today with an expected 25 bp hike. Forward guidance will be key. We strongly believe the Fed should not signal another skip in September, as doing so for the June meeting really handcuffed the Fed at a time when it needed maximum flexibility. Given how firm the labor market remains, we believe the right thing for the Fed to do is to emphasize a more data-dependent approach and stress that a skip in September should not be assumed. There won’t be updated macro forecasts and Dot Plots until the September meeting. WIRP suggests odds of a hike then around 20% and top out near 45% November 1.

As always, the press conference will be key. At the June presser, Chair Powell called the decision to hold rates “prudent” but added that the Fed will continue to make decisions meeting by meeting. Of course, this begs the question of how the Fed could pre-commit to a skip way back on May 3, well before the June 14 decision. Powell stressed in June that “It will be appropriate to cut rates at such time as inflation is coming down really significantly, and we’re talking about a couple years out.” It’s worth noting that the first cut is largely priced in for next May but this is of course open to repricing and dependent on the data.
The dollar tends to weaken on FOMC decision days. DXY has fallen six straight and ten of the past eleven. This covers the entirety of the Fed’s current tightening cycle, which seems counterintuitive given the large-scale hikes seen throughout. This may be a tad unfair but we can perhaps chalk up this price action to Powell’s press conference, where he often makes dovish slips that undermine the Fed’s hawkish message. Or else the market simply does not believe the Fed. Either way, it’s hard to argue with this streak.

Housing sector data will remain in focus. June new homes sales are expected at -5.0% m/m vs. 12.2% in May. Was the May spike a fluke or something bigger? Pending home sales will be reported tomorrow and are expected at -0.5% m/m vs. -2.7% in May.

Consumer confidence remains high. Conference Board reported its July measure and its headline came in at 117.0 vs. 112.0 expected and a revised 110.1 (was 109.7) in June. This was the highest since July 2021 and was driven by large increases in both present situation and expectations. University of Michigan reports its final July reading Friday. Its preliminary reading of 72.6 was the highest since September 2021 and this improvement lines up well with the Conference Board. Both readings suggest consumption is likely to hold up in Q3

Bank of Canada releases the summary of its deliberations. At the July 12 meeting, it hiked rates 25 bp to 5.0%. It said it now sees inflation returning to the 2% target by mid-2025 vs. end-2024 previously, adding that it is concerned progress towards it could stall. Updated macro forecasts were released. Later, Governor Macklem said the bank discussed holding rates and awaiting more data but decided that the cost of delay exceeded the benefit of waiting. He said the bank is prepared to hike again if needed but that it would assess rates on a decision-by-decision basis. Looking ahead, WIRP suggests 35% odds of a hike at the next meeting September 6, rising to over 70% October 25 and around 95% December 6. Of course, it will all come down to the data but if the economy remains firm, another hike seems likely.

EUROPE/MIDDLE EAST/AFRICA

Eurozone M3 data came in soft for June. M3 came in 0.6% y/y vs. 0.9% expected and a revised 1.0% (was 1.4%) in May. This was the slowest since July 2010 and signals slower economic activity ahead. This comes as no surprise after yesterday’s bank lending report from the ECB that showed a collapse in corporate borrowing in Q2. The negative news keeps piling up. On Monday, the eurozone reported weak preliminary July PMI readings. This Friday, we will start to get Q2 GDP data from the eurozone countries and we see clear downside risks.

The two-day ECB meeting begins today and ends tomorrow with an expected 25 bp hike. The big question is how the bank frames the debate about policy going forward. Given the recent softening in the data, we believe the ECB will stress its data-dependency and refrain from flagging another hike at the next meeting. Indeed, given the recent turnaround by noted bears Knot and Nagel coupled with the weaker data, WIRP suggest odds of another 25 bp hike stand have fallen below 50% September 14, rise to 70% October 26, and top out near 75% December 14. This second hike was fully priced in at the start of last week. Updated macro forecasts won’t come until the September meeting.

Junior doctors in the U.K. will strike for four days next month. The British Medical Association said these doctors will stage a 96 hour walkout starting at 7 AM August 11. This would be the fifth round of strikes for them. Elsewhere, senior doctors just staged a walkout last week and will hold another one August 24-25. Prime Minister Sunak has pledged not to make another wage offer beyond the 6% increase that was brokered earlier this month. Of note, inflation continues to fall, albeit slowly and not yet enough to get positive real wages. No wonder the 6% offer is seen as insufficient.

BOE tightening expectations remain subdued. WIRP suggests odds of a 50 bp hike August 3 have fallen to 40% after being largely priced in earlier this month. Looking ahead, 25 bp hikes are priced in September 21 and November 2 while odds of one last 25 bp hike top out near 60% in early 2024. This new expected rate path would see the bank rate peak between 5.75-6.0% vs. the 6.5% peak earlier this month. This is a huge downward adjustment that is taking a toll on sterling.

ASIA

Markets are getting a bit more concerned about a surprise from the Bank of Japan as Friday’s decision approaches. After testing the 142 area, USD/JPY is trading back near 140. In addition, 1-week yen risk reversals are trading near -4.20 and is a new low this year vs. March 9 (-4.175) and April 26 (-3.50), which were also just before BOJ decisions. What this means is that the options pricing is skewed towards a downward move vs. an upside move in USD/JPY. This simply reflects protection against a potential hawkish surprise from the BOJ that would lead to a surging yen.

Australia reported soft June and Q2 CPI data. Headline inflation came in as expected at 5.4% y/y in June vs. a revised 5.5% (was 5.6%) in May. This was the lowest since February 2022 but still well above the 2-3% target range. For Q2, headline came in at 6.0% y/y vs. 6.2% expected and 7.0% in Q1 while trimmed mean came in at 5.9% y/y vs. 6.0% expected and 6.6% in Q1. Here, this was the lowest reading since Q1 2022. Q2 PPI will be reported Friday. RBA expectations remain subdued. WIRP suggests less than 15% odds of a hike August 1 vs. 50% at the start of this week, rising to around 35% September 5 vs. 75% at the start of this week. Odds of a hike top out near 89% December 5 vs. being largely priced in for October 3 at the start of this week. There are no longer any odds of a second hike vs. nearly 60% in early 2024 at the start of this week.

China appointed Pan Gongsheng as the new PBOC Governor. The move was widely expected after outgoing Governor Yi Gang reached the mandatory retirement age of 65. Pan’s appointment is the first time since 2018 that the top two positions at the PBOC (Governor and Communist Party Secretary) will be held by the same person. Pan has been at the PBOC since 2012 and so his appointment signals continuity. That said, the change may lead the bank to enact another round of monetary stimulus. Elsewhere, Qin Gang was replaced after seven months, becoming the shortest-serving Foreign Minister ever. He was replaced by his predecessor Wang Yi. The reason why remains a mystery, as Qin was seen as a top ally of President Xi.

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