Dollar Remains Under Pressure Ahead of CPI

July 12, 2023

Win Thin

June CPI data take center stage; the Fed releases its Beige Book report for the July 25-26 FOMC meeting; BOC is expected to hike rates 25 bp to 5.0%
Portugal is the latest eurozone country to complain about tight monetary policy; BOE released its financial stability report
Japan reported weak May core machine orders; RBNZ kept rates steady at 5.5%, as expected

The dollar remains under pressure ahead of CPI data. DXY is trading lower for the fifth straight day near 101.472 and is the lowest since early May. That month’s low near 101 will surely be tested as bearish momentum builds. The euro is trading modestly higher near $1.1025 while sterling is trading modestly lower near $1.2920 after making a new cycle high earlier near $1.2970. USD/JPY is the big mover today and traded at the lowest level since mid-June near 139.30. We believe the fundamental story continues to favor the dollar; Fed tightening expectations have not shifted much even as the U.S. economy shows continued resilience. As such, we believe further losses will be limited. The inflation data will be key to further repricing of Fed policy and we view current dollar softness as a temporary setback.

AMERICAS

June CPI data take center stage. Headline is expected at 3.1% y/y vs. 4.0% in May and core is expected at 5.0% y/y vs. 5.3% in May. In m/m terms, headline is expected at 0.3% vs. 0.1% in May and core is expected at 0.3% vs. 0.4% in May. Of note, the Cleveland Fed’s Nowcast sees headline up 0.42% m/m and 3.22% y/y and core up 0.43% m/m and 5.11% y/y, both slightly higher than consensus. Looking ahead, the model sees both y/y rates accelerating in July to 3.62% and 5.22%, respectively. PPI will be reported tomorrow, with headline expected at 0.4% y/y vs. 1.1% in May and core expected at 2.6% y/y vs. 2.8% in May.

The Fed releases its Beige Book report for the July 25-26 FOMC meeting. Here is our take on economic conditions since the May 31 Beige Book report for the June 13-14 FOMC meeting. On overall economic activity: Economic activity has shown some pockets of weakness, though the housing sector has proven surprisingly resilient and Q2 GDP is still growing near 2% SAAR . On labor markets: Employment growth has slowed modestly even as initial claims have crept higher. Overall, the labor market remains fairly strong and JOLTS job openings near 10 mln suggest firms are still having difficulty finding workers. On prices: Headline readings continue to fall due mainly to energy prices while core readings remain elevated due to services. Bottom line: this Beige Book report should set the table for a 25 bp hike this month. Barkin, Kashkari, Bostic, and Mester speak today.

Bank of Canada is expected to hike rates 25 bp to 5.0%. However, a quarter of the analysts polled by Bloomberg see steady rates and WIRP suggests 70% odds of a hike. After Friday’s strong jobs report, we believe a hike is a done deal. Updated macro forecasts will also be released. At the last meeting June 7, it delivered a hawkish surprise and hiked rates 25 bp to 4.75% and noted “Overall, excess demand in the economy looks to be more persistent than anticipated.” It added that “Monetary policy was not sufficiently restrictive to bring supply and demand into balance and return inflation sustainably to the 2% target.” Lastly, the bank stressed “Concerns have increased that CPI inflation could get stuck materially above the 2% target.” Looking ahead, WIRP suggests odds of another 25 bp hike top out near 70% October 25.

EUROPE/MIDDLE EAST/AFRICA

Portugal is the latest eurozone country to complain about tight monetary policy. Finance Minister Medina warned that “The risks that further increases could create a more difficult situation for growth at the European level are now higher and should be looked at very carefully.” He noted that inflation is already falling even as the impact of previous rate hikes have to be fully felt by households and companies. Italy was the first to broach this subject when senior government officials recently spoke out against higher interest rates. ECB tightening expectations remain steady. WIRP suggests a 25 bp hike is nearly priced in July 27. Odds of another 25 bp hike stand near 65% September 14 and is fully priced in October 26. Odds of a third hike top out near 20% in early 2024. Vujcic and Lane speak later today.

The Bank of England released its financial stability report. The bank warned that around 4 mln households will face a sharp jump in mortgage costs, with the average borrower seeing a monthly increase of GBP220, or nearly GBP3000 per annum. Governor Bailey later said “It will take time for the full impact of higher interest rates to come through both in the U.K. and in other advanced economies. Elements of the global financial system do remain vulnerable to interest rates.” He added that “Compared to previous periods of high interest rates, households and businesses are less likely to cut back on spending and default on loans.” Lastly, the BOE said that the eight largest U.K. banks all passed its latest stress tests and noted that “The U.K. banking system has the capacity to support households and businesses through a period of higher interest rates, even if economic and financial conditions were to be substantially worse than expected. The scenario is considerably more severe than the current macroeconomic outlook.”

ASIA

Japan reported weak May core machine orders. Orders came in at -8.7% y/y vs. 0.1% expected and -5.9% in April, and comes after weak June machine tool orders were reported yesterday. Continued weakness in orders supports our view that Japan has yet to see any significant impact from China reopening. June PPI was also reported and came in at 4.1% y/y vs. 4.4% expected and 5.1% in May. With the economy softening and price pressures easing, market expectations for Bank of Japan liftoff have been pushed into 2024.

Reserve Bank of New Zealand kept rates steady at 5.5%, as expected. This was the first hold since the bank started tightening back in 2021. It noted that “Interest rates are constraining spending and inflation pressure as anticipated and required. The Committee is confident that with interest rates remaining at a restrictive level for some time, consumer price inflation will return to within its target range.” There were neither updated macro forecasts nor a press conference by Governor Orr. Both will come at the August 16 meeting. It remains to be seen whether the RBNZ is eventually forced to restart the tightening cycle but for now, WIRP suggests only 10% odds of a hike next month, rising to around 25% October 4 and then topping out near 50% November 29. At the same time, easing is not priced in until mid-2024.

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