Dollar Flat Ahead of ECB Decision

September 14, 2023

Win Thin

August retail sales data will be the highlight; August PPI data will also be reported; U.S. financial conditions continue to loosen; Peru is expected to cut rates 25 bp to 7.5%
The ECB decision is due out shortly and markets are split; as always, Madame Lagarde’s press conference will be key; Sweden reported soft August CPI data
Japan reported weak July core machine orders; Australia reported strong August jobs data

The dollar is trading flat ahead of the ECB decision. DXY is trading flat near 104.746 after two straight up days and remains on track to test to March high near 105.883. The euro is trading flat near $1.0730 ahead of the ECB decision (see below) and remains on track to test the May low near $1.0635. Sterling is trading lower near $1.2465 and remains on track to test the May low near $1.2310. USD/JPY is trading flat near147.35 and remains on track to test 150. We believe the fundamental story remains in favor of the greenback. Looking through the recent noise, the U.S. remains in a much stronger position than the other major economies such as the eurozone or the U.K. Indeed, the worsening outlook in Europe should lead the ECB to deliver a dovish message today. Along with firm U.S. data, this would feed into further dollar strength.

AMERICAS

August retail sales data will be the highlight. Headline sales are expected at 0.1% m/m vs. 0.7% in July, while sales ex-autos are expected at 0.4% m/m vs. 1.0% in July. The so-called control group used for GDP calculations is expected at -0.1% m/m vs. 1.0% in July. We note that base effects from last year are high and so the y/y rates are likely to drop fairly significantly. Consumption has held up relatively well in recent months and is currently driving solid Q3 growth. We downplay suggestions that consumption will weaken as excess savings are eaten up; the U.S. has never been a high savings nation and we believe consumption is driven more by rising wages and a robust labor market.

August PPI data will also be reported. Headline is expected at 1.3% y/y vs. 0.8% in July, while core is expected at 2.2% y/y vs. 2.4% in July. Yesterday, CPI came in on the high side. Headline came in a tick higher than expected at 3.7% y/y vs. 3.2% in July, while core came in as expected at 4.3% y/y vs. 4.7% in July. However, the m/m gain in core CPI came in a tick higher than expected at 0.3% vs. 0.2% in both June and July. Looking ahead to September, the Cleveland Fed’s Nowcast model suggests headline and core inflation readings of 3.8% and 4.3%, respectively.

Recent data suggest a pause is warranted by the Fed next week. WIRP suggests less than 5% odds of a hike next Wednesday. Yet when all is said and done, headline inflation is creeping back towards 4% and core inflation is stuck above 4%. The Fed is nowhere near done and so we expect a 25 bp hike November 1. By that November meeting, we will get one more jobs report, one more CPI reports, and two each of PPI, retail sales, and PCE. If things go the way we expect for the U.S. data, the current 50% odds of another hike 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 through last Friday are the loosest since early March 2022, right before the Fed started hiking rates on March 16 2022. The Fed clearly has to do more in order to rein in the red hot US economy. The Atlanta Fed's GDPNow model is now tracking Q3 growth at 5.6% SAAR. Next model update comes next today after the data.

Weekly jobless claims and July business inventories will also be reported. Initial claims are expected at 225k vs. 216k last week while continuing claims are expected at 1.693 mln vs. 1.679 mln last week. Last week’s readings were much lower than expected and signal continued tightness in the labor market. Of note, next week’s initial claims reading will be for the BLS survey week containing the 12th of the month. There is no Bloomberg consensus yet for NFP but its whisper number currently stands at 171k.

Peru central bank is expected to cut rates 25 bp to 7.5%. However, nearly a quarter of the analysts polled by Bloomberg see steady rates. If the bank does cut today, it would mark the start of an easing cycle after the tightening cycle ended with the last 25 bp hike back in January. Bloomberg consensus sees another 75 bp of easing in Q4 followed by another 75 bp each in Q1 and Q2, 50 bp in Q3, and 25 bp in Q4 that would see the policy rate end next year at 4.5%. Such an aggressive easing cycle would certainly take a toll on the sol. July GDP proxy will be reported Friday and is expected at -0.1% y/y vs. -0.6% in June.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank decision is due out shortly and markets are split. Of the 66 analysts polled by Bloomberg, 34 see no change and 32 see a 25 bp hike to 4.0%. Similarly, WIRP suggest odds of a 25 bp hike stand near 65% but rise to 85% October 26 and fully priced in for December 14. No more hikes are seen after that. 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. The euro’s performance on ECB decision days has been mixed of late. Of the past four, the euro has ended higher twice and lower twice. Before that, however, the euro weakened four straight and seven of eight.

As always, Madame Lagarde’s press conference will be key. Recall that last time, she brought up the possibility of a pause for the first time this cycle and so this time, she may acknowledge that a peak is upon us. Since then, the account of that meeting showed that a hold was the initial preference before policymakers decided on a 25 bp hike. We expect a downbeat, dovish tone from Lagarde. Updated macro forecasts will also be released. As per recent press reports, we expect growth forecasts to be revised down and inflation forecasts to be revised up. Lagarde speaks again tomorrow, along with Villeroy.

Sweden reported soft August CPI data. Headline came in at 7.5% y/y vs. 7.7% expected and 9.3% in July, CPIF came in at 4.7% y/y vs. 4.9% expected and 6.4% in July, and CPIF ex-energy came in at 7.2% y/y vs. 7.4% expected and 8.0% in July. CPIF inflation was the lowest since February 2022 but still well above the 2% target. At the last policy meeting June 29, the Riksbank hiked rates 25 bp to 3.75% and said rates would be hiked at least one more time this year and noted that the weak krona is contributing to high inflation. Since then, SEK was weakened nearly -1.5% vs. EUR and -3% vs. USD. EUR/SEK is trading near the record high of 11.9635 from August. WIRP suggests a 25 bp hike to 4.0% at next week’s meeting is fully priced in. Looking ahead, the market sees about 50% odds of one last 25 bp hike to 4.25% over the next six months. We think that will be largely determined by the krona.

ASIA

Japan reported weak July core machine orders. Orders came in at -13.0% y/y vs. -10.3% expected and-5.8% in June. This was the weakest since August 2020, but orders have been weakening all year and we expect that trend to continue. We note that Q2 GDP growth was revised down due largely to weaker business spending, and the orders data suggest softness is likely to carry over into Q3. With wage growth remaining too low, we do not expect the Bank of Japan to remove accommodation anytime soon. No change is expected at next week’s meeting. WIRP suggests 20% odds of liftoff October 31, rising to nearly 50$ December 19 and nearly priced in for January 23.

Australia reported strong August jobs data. A total of 64.9k jobs were added vs. 25.0k expected and a revised -1.4k (was -14.6k) in July. However, the mix was not good as full-time jobs rose only 2.8k and part-time jobs surged 62.1k. The participation rate rose to 67.0% vs. a revised 66.9% (was 66.7%) in July, while the unemployment rate remained steady as expected at 3.7%. Of note, the Sahm rule would be triggered when the 3-month average for the unemployment rate rises 0.5 percentage points above the low of 3.4% in October. We are not quite there yet but it’s only a matter of time. Next RBA meeting is October 3 and WIRP suggests virtually no odds of a hike then. Those odds rise modestly to top out near 45% in Q1 but we believe the tightening cycle has ended.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2022. All rights reserved.