Dollar Firm as BOE and BOJ Tightening Expectations Sink

July 19, 2023

Win Thin

The relative view in FX that we highlighted yesterday appears to be taking hold; June retail sales data suggest the U.S. consumer remains active; housing data will get some attention; Canada June CPI data came in soft
Final June eurozone core inflation was revised higher; U.K. reported soft June CPI data; South Africa reported soft June CPI data
BOJ Governor Ueda implied policy would remain steady for now; New Zealand reported Q2 CPI data

The dollar is finally getting some traction. DXY is trading higher for the second straight day near 100.196, the highest since last Thursday. The euro is trading lower near $1.1215 despite the upward revision to core inflation as markets rethink the hawkish ECB narrative. Sterling is underperforming today after soft U.K. CPI data (see below) and is trading just above $1.29 after trading Friday at the highest since April 2022 near $1.3140. Cable recorded an outside down day yesterday and so further losses are likely. USD/JPY is testing the 140 area after BOJ Governor Ueda comments (see below) implied no change in policy next week. We had been frustrated with recent dollar weakness but the relative fundamental story seems to be shifting back in favor of the greenback (see below). Cracks are widening in the rest of the world and markets seem to be finally taking note and so further dollar gains seem likely.

AMERICAS

The relative view in FX that we highlighted yesterday appears to be taking hold. Relative interest rate differentials and reIative growth rates are the two most important ones for the market. The euro and sterling are two of the top three performing majors year to date. Yet we are beginning to see larger cracks form in these two currencies, with ECB hawks getting less hawkish and U.K. inflation easing faster than expected (see below). On the other hand, yesterday’s retail sales data suggests the U.S. economy remains robust and supports our view that markets continue to underestimate the Fed’s capacity to tighten. To us, the relative view doesn’t look as good for the euro and sterling as it used to. Indeed, the 2-year yield differentials have started to move back in the dollar’s favor and we see this trend continuing.

June retail sales data suggest the U.S. consumer continues to consume. Headline came in at 0.2% m/m vs. 0.5% expected, sales ex-auto came in at 0.2% m/m vs. 0.3% expected, and the so-called control group used for GDP calculations came in at 0.6% m/m vs. 0.3% expected. However, the May readings were all revised higher and so the net message is that consumption continues to hold up. Of note, growth in the control group was steady at 3.8% y/y. Markets should not just rely on retail sales data to gauge the strength of the consumer, as this data only covers goods. Personal spending measures service spending too and will give a much fuller picture, but the June reading won’t be reported until July 28 along with PCE data. The Atlanta Fed’s GDPNow model is now tracking Q2 growth of 2.4% SAAR vs. 2.3% previously. Next model update comes today after the data.

Housing data will get some attention. June building permits and housing starts are expected at 0.2% m/m and -9.3% m/m, respectively. June existing home sales will be reported tomorrow and are expected at -2.2% m/m vs. 0.2% in May. Was the unexpected jump in May new home sales just a fluke or something more sustainable? We should know more after this round of housing data. Yesterday, July NAHB housing market index came in as expected at 56 vs. 55 in June and was the highest since June 2022.

Canada June CPI data came in soft. Headline came in at 2.8% y/y vs. 3.0% expected and 3.4% in May, while core median was steady at 3.9% y/y and core trim a fell a tick to 3.8% y/y. Headline is the lowest since March 2021 but still above the 2% target. More importantly, core inflation remains stubbornly high. Bank of Canada just hiked rates 25 bp to 5.0% last week and 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 nearly 40% odds of a hike September 6, rising to nearly 75% December 6. Whether there is another hike will all come down to the data.

EUROPE/MIDDLE EAST/AFRICA

Final June eurozone core inflation was revised higher. Core inflation was revised up a tick from the preliminary to 5.5%, while headline remained unchanged at 5.5%. That means core has not cooled as much as desired and is hovering just below the 5.7% peak in March. Yet ECB tightening expectations remain muted ahead of next week’s meeting. WIRP suggests a 25 bp hike is still nearly priced in July 27. However, odds of another 25 bp hike September 14 stand near 65% vs. 65% at the start of this week and top out near 75% December 14 after being largely priced in previously. Reports suggest bank officials are concerned about its messaging at next week’s meeting. That was made clear earlier this week, when leading hawks Knot and Nagel both called into question a hike at the September meeting.

U.K. reported soft June CPI data. Headline came in at 7.9% y/y vs. 8.2% expected and 8.7% in May, core came in at 6.9% y/y vs. 7.1% expected and actual in May, and CPIH came in at 7.3% y/y vs. 7.5% expected and 7.9% in May. Headline was the lowest since March 2022 but still well above the 2% target. BOE tightening expectations have fallen as a result of the soft data. WIRP suggests odds of a 50 bp hike August 3 have fallen to 45% after being largely priced in at the start of this week. Looking ahead, 25 bp hikes September 21 and November 2 are priced in but after that, the odds of one last 25 bp hike top out near 55% in February. This new expected rate path would see the bank rate peak between 5.75-6.0% vs. 6.25% at the start of this week and 6.5% at the start of last week. This is a huge downward adjustment that is taking a toll on sterling. Ramsden speaks today.

South Africa reported soft June CPI data. Headline inflation came in a tick lower than expected at 5.4% y/y vs. 6.3% in May, while core also came in a tick lower than expected at 5.0% y/y vs. 5.2% in May. Headline was the lowest since October 2021 and back within the 3-6% target range for the first time since April 2022. The South African Reserve Bank meets tomorrow and is expected to hike rates 25 bp to 8.5%. However, a third of the 27 analysts polled by Bloomberg see steady rates. We warn of a dovish surprise after the CPI data. At the last meeting May 25, the bank hiked 50 bp to 8.25% and raised its inflation forecasts whilst warning of further rand weakness ahead. Looking ahead, the market is pricing in the start of an easing cycle in H1 of next year. May retail sales will be reported later today and are expected at -1.1% y/y vs. -1.6% in April.

ASIA

Bank of Japan Governor Ueda implied policy would remain steady for now. Noting that the bank is working with the premise that it has not yet met its inflation target, he said “We check the premise at every policy meeting and I would like to say that, unless the premise is shifted, the whole story will remain unchanged.” New macro forecasts will be released at the upcoming July 27-28 meeting and should show upward revisions to the inflation outlook, though reports suggest the revisions will be minor. His comments pushed back against growing speculation that the BOJ will tweak its Yield Curve Control next week. The last tweak was the surprising widening of the 10-year JGB yield trading band to 0% +/- 50 bp. JGB yields have crept higher in anticipation of a YCC tweak but we remain skeptical of a move so soon and instead believe it is more likely to come in the autumn. Either way, expected liftoff has been pushed into 2024 and we concur.

New Zealand reported Q2 CPI data. Headline came in at 6.0% y/y vs. 5.9% expected and 6.7% in Q1, while the q/q rate came in at 1.1% vs. 0.9% expected and 1.2% in Q1. This was the lowest y/y rate since Q4 2021 but still well above the 1-3% target range. However, core inflation remained steady at 5.8% y/y, the highest on record. The RBNZ just left rates steady at 5.5% and 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.” It remains to be seen whether the RBNZ is eventually forced to restart the tightening cycle but for now, WIRP suggests only 20% odds of a hike August 16, rising to around 33% October 4 and then topping out near 55% in early 2024.

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