• June inflation data this week have led to some big market moves; the FOMC will likely tilt more dovish with the departure of St. Louis Fed President James Bullard; preliminary July University of Michigan consumer sentiment will be the highlight
  
• U.K. Prime Minister Sunak signed off on pay rises for public sector workers; Sweden reported June CPI; Israel reports June CPI
  
• Chatter is picking up of a potential tweak to YCC this month; other reports suggest only modest changes will be made to the inflation forecasts; Australia Treasurer Chalmers picked RBA Deputy Governor Michele Bullock to be the next Governor

The dollar is stabilizing ahead of the weekend. DXY is trading slightly higher just below 100 after six straight down days. Clean break below 100 sets up a test of the late March 2022 low near 97.685. The euro traded at the highest since March 2022 near $1.1245 and is on track to test of the February 2022 high near $1.15. Similarly, cable traded at the highest since April 2022 near $1.3140 and is on track to test its March 2022 high near $1.33. USD/JPY traded at the lowest since May near 137.25 but has since recovered to trade just below 139. Clean break below 138 sets up a test of the mid-May low near 133.75. We remain frustrated with this ongoing dollar weakness, which we view as being at odds with the underlying fundamental story. However, we have to respect the price action. The bearish momentum remains too strong right now and so further near-term losses are likely.

AMERICAS

June inflation data this week have led to some big market moves. The US 2-year yield remains nearly 50 bp below last week’s peak near 5.12%. in turn, this has fed into a massive dollar selloff. Has the underlying story really changed that much? We say no. Yes, June inflation readings surprised a bit to the downside but this was due largely to high base effects that will be reversed in July and beyond. Underlying price pressures remain strong and the labor market remains tight as weekly initial claims came in yesterday at 237k, back near the recent lows. If this drop is sustained for this BLS survey week, we would expect another solid jobs report for July. Fed expectations really haven’t shifted enough to warrant a 50 bp drop in the 2-year yield. WIRP still suggests a hike this month is pretty much priced in, with the odds of a second hike still lingering around 20%. The first cut is fully priced in for May vs. June/July last week.

The FOMC will likely tilt more dovish with the departure of St. Louis Fed President James Bullard. He resigned to become the Dean of Mitchell E. Daniels, Jr. School of Business at Purdue University. Bullard will remain at the Fed in an advisory role until August 14 but has recused himself from his monetary policy role on the FOMC and has ceased all public speaking. As the leading hawk at the Fed, his replacement will almost by default be more dovish. Of note, regional Fed presidents are chosen by the boards of each bank rather than President Biden, who nominates members of the Fed Board of Governors. Bullard emerged as a persuasive thought leader on the FOMC and has proven quite prescient about persistent inflation and the need for aggressive Fed tightening. Even though he is not a voter this year, we have no doubt that he has driven the debate about the need for further tightening.

Bullard will be missed but the torch will be carried by his former protégé and current Fed Governor Waller. To wit, Waller said yesterday that “I see two more 25 bp hikes in the target range over the four remaining meetings this year as necessary to keep inflation moving toward our target. I see no reason why the first of those two hikes should not occur at our meeting later this month.” Elsewhere, Daly said “It’s really too early to say that we’ve declared victory on inflation.” While acknowledging that recent inflation “is very positive,” she said she’s in a “wait-and-see mode on that, because I remain resolute to bring inflation down to 2%.” Goolsbee speaks today. He has emerged as a prominent dove and so we expect his remarks to reflect this. At midnight tonight, the media blackout goes into effect and there will be no Fed speakers until Chair Powell’s post-decision press conference July 26.

Preliminary July University of Michigan consumer sentiment will be the highlight. Headline is expected at 65.5 vs. 64.4 in June. 1-year inflation expectations are expected at 3.1% vs. 3.3% in June, while 5 to 10-year expectations are seen steady at 3.0%. This comes ahead of June retail sales data next Tuesday. Can confidence and consumption hold up? Recent data suggest yes. Consensus sees headline sales up 0.5% m/m, ex-auto up 0.4%, and the so-called control group used for GDP calculations up 0.4%. June import/export prices will be reported. Bottom line: the U.S. economy remains fairly robust as we move into H2. Yes, there are some pockets of softness but the economy continues grow near trend at a time when the Fed is seeking below trend growth. The Atlanta Fed’s GDPNow model is currently tracking 2.3% SAAR in Q2 and the next model update comes next Tuesday after the retail sales data.

EUROPE/MIDDLE EAST/AFRICA

U.K. Prime Minister Sunak signed off on pay rises for public sector workers in a bid to halt ongoing strikes. Police pay will see a 7% increase, teachers will see a 6.5% increase, and doctors will see a 6% increase. These numbers are in line with recommendations from the official public pay review bodies, according to Treasury Minister John Glen. The government also announced pay awards for the armed forces and prison officers, and said there would be no new borrowing or spending to fund the extra pay. Sunak promised that services would not be cut whilst noting that “We only have a fixed pot of money to spend from. That means government departments have had to find savings and efficiencies elsewhere in order to prioritize paying public sector workers more.” The government estimates the pay raises will cost about GBP2 bln, which seems too low as it is a mere fraction of the overall public sector pay bill of GBP233 bln in FY2021-22. Sunak said some of that would be recouped by lifting the costs of U.K. visas and the costs for migrants to use the NHS. Sunak also said “There will be no more talks on pay. We will not negotiate again on this year’s settlements, and no amount of strikes will change our decision.” The heads of the teaching unions have said they would recommend members to accept the pay settlement and end strike action but the other unions may prove tougher to persuade. Stay tuned.

BOE tightening expectations have fallen. WIRP suggests another 50 bp hike is largely priced August 3, followed by 25 bp hikes September 21 and November 2. After that, the odds of a last 25 bp top out near 75% in Q1, which would see the bank rate peak near 6.25% vs. 6.5% at the start of this week. This would still represent the most aggressive tightening cycle in the majors so far in terms of absolute magnitude and so a deep recession is now back on the table after some earlier optimism that one might be avoided. Updated macro forecasts will come at the August meeting and will have to acknowledge the worsening backdrop.

Sweden reported June CPI. Headline came in at 9.3% y/y vs. 9.0% expected and 9.7% in May, CPIF came in at 6.4% y/y vs. 6.0% expected and 6.7% in May, and CPIF ex-energy came in at 8.1% y/y vs. 7.9% expected and 8.2% in May. If so, CPIF would be the lowest since April 2022 but still well above the 2% target. At the last meeting June 28, the Riksbank hiked rates 25 bp to 3.75% and said rates would be hiked at least one more time this year, noting that the weak krona is contributing to high inflation. It also announced that it would accelerate QT to SEK5 bln per month vs. SEK3.5 bln previously and noted “This may contribute to a stronger krona and improve the Riksbank’s capacity to reduce inflation. It is still uncertain how much monetary policy tightening will be required for inflation to fall back and stabilize close to the target of 2%. But the Riksbank will do what is needed.” The swaps market sees around 65% odds of a 25 bp hike at the next meeting September 21 but fully priced in for November 23. Looking ahead, the market sees around 50% odds of another 25 bp hike in H1 2024 and we expect those odds to rise if inflation remains stubbornly high.

Israel reports June CPI. Headline is expected to fall two ticks to 4.4% y/y. If so, it would continue the deceleration from the 5.4% peak in January to the lowest since June 2022. Bank of Israel kept rates steady at 4.75% this Monday but warned of further hikes. Governor Yaron said “We are in an environment of great uncertainty, and there are several upside risks to inflation pressures. It is certainly possible that we will need to increase the interest rate going forward, if we see evidence that the inflation environment is not moderating at a suitable pace.” Of note, Yaron is coming under intense criticism from members of the ruling coalition, setting up the possibility that central bank independence will be the next to come under fire after the judiciary. If so, shekel weakness would undoubtedly intensify.

ASIA

Chatter is picking up of a potential tweak to Yield Curve Control this month. The Bank of Japan meets July 27-28 and former bank official Hideo Hayakawa said it will probably adjust YCC given that inflation is higher than expected. He said “I expect they will make some kind of adjustment to YCC this month. If they don’t, it doesn’t make sense.” He added that the central bank is likely to end yield control and hike rates early next year, adding that “There is a good chance that the BOJ will attain its price target.” That said, he worked at the BOJ from 1977-2013 and so his insights are no better or no worse than any other analyst. 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 at this meeting, and instead believe it is more likely to come in the autumn. Either way, expected liftoff has been pushed into 2024 and we concur.

Other reports suggest only modest changes will be made to the inflation forecasts. The latest suggests the BOJ will likely raise its FY23 inflation forecast above 2.0% vs. 1.8% currently whilst keeping it largely unchanged for FY24 or perhaps even nudging it lower from 2.0% currently. Bank officials will reportedly finalize the new inflation forecasts after assessing economic data and financial market conditions right up to the last minute, when the BOJ release its quarterly outlook report on July 28 at the end of its policy meeting.

Australia Treasurer Chalmers picked RBA Deputy Governor Michele Bullock to be the next Governor. She will be the first female Governor of the RBA and Chalmers said “Bullock is the right person to lead the RBA into the future and ensure we have the world’s best and most effective central bank.” Her seven-year term will begin on September 18. Bullock became Deputy Governor in April 2022 but has worked at the RBA since 1985, when she joined as an intern. She has a master’s degree from the London School of Economics. We do not expect any significant shift in policy under Bullock. WIRP suggests only 30% odds of a 25 bp hike at the next meeting August 1, with the odds rising steadily to being fully priced in for November 7.