Euro Under Pressure as Data Fuel Talk of Stagflation

August 31, 2023
  • We are at the point where the market is overreacting to every data point; Fed tightening expectations took a hit from the weak U.S. data; July PCE readings will be very important; Chicago PMI will also be closely watched
  • Eurozone August CPI data came in hot; yet ECB tightening expectations remain subdued; ECB publishes the account of its July 21 meeting; Germany reported weak data
  • Japan reported mixed July retail sales, IP, and housing starts; BOJ board member Toyoaki Nakamura urged caution; New Zealand opposition National Party pledged to remove the RBNZ’s dual mandate if it wins the October election; China reported official August PMIs

The dollar is recovering as data from Europe take a toll on the euro. Weak growth and high inflation are reviving talk of eurozone stagflation risks (see below). DXY is trading higher near 103.553 after three straight down days. The euro is underperforming and trading lower near$1.0870 and has given up nearly all of yesterday’s gains. Sterling is being dragged down and trading lower near $1.2680. USD/JPY is trading lower near 145.90 despite dovish comments from a BOJ board member (see below). Despite the recent soft U.S. data, we believe the fundamental story remains in favor of the greenback. Last Friday’s speech by Powell confirms the Fed’s hawkish stance and we think another hike could be confirmed by firmer U.S. data this week. Since the Fed is in data dependent mode, so too is the market and so we have to be prepared for possible dislocations with every data point, both major and minor. Looking through the noise, the U.S. appears to be in a much strong position than the other major economies such as the eurozone or the U.K.


We are at the point where the market is overreacting to every data point, good or bad, minor or major. Unfortunately, that is what data dependence has wrought and this will continue right up to the September FOMC meeting. JOLTS, ADP, Q2 GDP, and Conference Board consumer confidence have all taken a toll on the dollar this week. Until today, as developments abroad have cast a much better light on the U.S. Weak growth and high inflation readings out of the eurozone have brought stagflation risks there back into the spotlight (see below). And so we are reminded once again that in the wonderful world of FX, being negative on the dollar requires being positive on another currency and right now, there aren’t any strong candidates.

Fed tightening expectations took a hit from the weak U.S. data. Odds of a Fed hike in September are now back to 10% after hitting nearly 25% on Tuesday. The odds of a November hike are now back to 50% after rising to over 70% on Tuesday. Obviously, this is all data dependent but if the data remain firm as we expect, these odds should continue to rise and underpin the dollar. Bostic and Collins speak today. Bostic and Mester speak tomorrow. Of these speakers, Bostic is the most dovish while Mester is the most hawkish. True to form, Bostic said today that “Based on current dynamics in the macroeconomy, I feel policy is appropriately restrictive.”

July PCE readings will be very important. Headline is expected at 3.3% y/y vs. 3.0% in June, while core is expected at 4.2% y/y vs. 4.1% in June. Of note, the Cleveland Fed’s Nowcast model estimates July headline and core PCE at 3.2% y/y and 4.2% y/y, respectively. For August, the Cleveland Fed estimates headline and core PCE at 3.6% y/y and 4.0% y/y, respectively. In other words, not much progress in meeting the 2% target is likely near-term. Until the economy slows to sub-trend growth and the labor market loosens, it’s hard to see how we can get significant disinflation and so we believe the Fed will have to go higher for longer, as it has promised. Personal income and spending will be reported at the same time and are expected at 0.3% m/m and 0.7% m/m, respectively. In y/y terms, the retail sales “control group” picked up in July and we expect personal spending (which includes services) to also remain firm.

Other labor market data will be reported today. August Challenger job cuts and weekly jobless claims will be reported. Initial claims are expected at 235k vs. 230k last week while continuing claims are expected at 1.706 mln vs. 1.702 mln last week. The lack of layoffs in the JOLTS data as well as downward pressure on weekly claims suggest the labor market, while perhaps softening, remains relatively tight.

Chicago PMI will also be closely watched. Headline is expected at 44.2 vs. 42.8 in July. Think of it as an appetizer ahead of ISM manufacturing PMI tomorrow. There, headline is expected at 47.0 vs. 46.4 in July. Keep an eye on prices paid and employment, which stood at 42.6 and 44.4 in July, respectively.

ADP reported its private sector jobs estimate. It came in at 177k vs. 195k expected and a revised 371k (was 324k) in July. Consensus sees 170k for NFP vs. 187k in July, while the unemployment rate is seen steady at 3.5% and average hourly earnings are seen falling a tick to 4.3% y/y. Of note, Bloomberg’s whisper number stands at 166k and the fact that it’s lower than the consensus shows that the market is leaning less constructive on the U.S. economy.

We got a downward revision to Q2 GDP. Growth was revised to 2.1% SAAR vs. 2.4% previously. Personal consumption added 1.14 ppt to growth vs. 1.12 previously, investment added 0.66 ppt vs. 0.83, government consumption added 0.58 ppt vs. 0.45, net exports subtracted -0.22 ppt vs. -0.12, and inventories subtracted -0.09 vs. adding 0.14 previously. Final sales grew 2.2% vs. 2.3% previously. However, this is old news as markets look ahead to Q3 and Q4. In that regard, the Atlanta Fed’s GDPNow model is tracking Q3 growth at 5.9 % SAAR vs. 2.4% in Q2. While this is likely to be revised down in the coming weeks, we think it is likely to mark the fifth straight quarter of at or above trend growth at a time when the Fed is trying to engineer below trend growth. Next model update comes today after the data. Of note, Bloomberg consensus sees Q3 growth at 2.0% SAAR and Q4 at 0.4% SAAR.


Eurozone August CPI data came in hot. Headline came in at 5.3% y/y vs. 5.1% expected and 5.3% in July, while core came in as expected at 5.3% y/y vs. 5.5% in July. France and Italy reported earlier and France’s EU Harmonised inflation came in at 5.7% y/y vs. 5.4% expected and 5.1% in July, while Italy’s came in at 5.5% y/y vs. 5.6% expected and 6.3% in July. The upside surprise was not that much of a surprise after Germany reported higher than expected CPI yesterday. Basically, disinflation has stalled out in the eurozone and so the policy debate will most likely swing to the hawks’ favor. Indeed, Holzmann said today that the ECB may extend its tightening cycle by “another hike or two.” Schnabel was more nuanced, noting that recent data “point to growth prospects being weaker than foreseen in the baseline scenario. But underlying price pressures remain stubbornly high, with domestic factors now being the main drivers of inflation in the euro area.”

Yet European Central Bank tightening expectations remain subdued. WIRP suggest odds of a 25 bp hike stand just below 30% September 14, rise to over 50% October 26 and top out near 65% December 14. What’s very interesting to us is that these odds have actually fallen since the start of this week, meaning that neither the higher than expected August CPI data nor hawkish ECB comments have had any impact on ECB expectations whatsoever. Market chatter regarding stagflation risks is picking up. If this dynamic is sustained, it would be a game-changer for the euro. Lastly, we stress again that the ECB may stop hiking before the Fed does and we don't think the markets have priced this risk in yet.

The European Central Bank publishes the account of its July 21 meeting. At that meeting, it hiked 25 bp but the forward guidance shifted less hawkish as the ECB said inflation will drop further over the remainder of the year. Madame Lagarde highlighted downside risks, noting that the economy is likely to remain weak in the short run as the near-term outlook has deteriorated. More importantly, she said the ECB has an open mind about its decisions in September and beyond, adding that September could be a hike or a pause, but not a cut. Recall that at the June meeting, Lagarde said that the ECB is not “thinking about” pausing. At Jackson Hole, Lagarde refrained from talking about a pause.

Germany reported weak data. July retail sales came in at -0.8% m/m vs. 0.3% expected and a revised -0.2% (was -0.8%) in June. in y/y WDA terms, sales came in at -2.2% vs. -0.9% in June and was the worst since April. August unemployment came in at 18.0k vs. 10.0k expected and a revised 1.0k (was -4.0k) in June, while the unemployment rate remained steady at 5.7% from an upwardly revised reading (was 5.6%) in June. Elsewhere, France reported July consumer spending at -1.1% y/y vs. -2.8% in June after it had already reported July retail sales at -2.1% y/y vs. -2.0% in June. Eurozone retail sales will be reported September 6.


Japan reported mixed July retail sales, IP, and housing starts. Sales came in at 6.8% y/y vs. 5.5% expected and 5.6% in June, while IP came in at -2.5% y/y vs. -1.4% expected and 0.0% in June. Housing starts came in at -6.7% y/y vs. -1.3% expected and -4.8% in June. Despite the stronger than expected GDP growth in Q2, the data have been coming in mixed so far in Q3 and we believe that is making policymakers nervous.

Bank of Japan board member Toyoaki Nakamura urged caution. Specifically, he said “We still need more time before turning to policy tightening. The sustainable and stable achievement of the 2% inflation target accompanied by wage growth isn’t in sight yet.” This is the polar opposite of board member Naoki Tamura’s comment yesterday when he said “The achievement is finally and clearly within sight after a decade of large-scale monetary easing aimed at attaining it.” Tamura raised the possibility of liftoff, acknowledging that “Removing the negative rate would naturally be one of the options.” That said, Tamura is one of the only hawks on the BOJ board and we believe most are closer in stance to the dovish Nakamura. As such, we do not think the BoJ will remove accommodation anytime soon. Next policy meeting is September 21-22 and no change is expected then.

New Zealand opposition National Party pledged to remove the RBNZ’s dual mandate if it wins the October election. The party’s finance spokesperson Willis said “I can say that we’ll be moving to do that quite quickly on forming government. What we want to do is return to the conventional mandate that New Zealand had in place for many years whereby the inflation target was the key objective.” Since taking office in 2017, the ruling Labour Party has overhauled the RBNZ by expanding its mandate to include both stable prices and maximum sustainable employment. It also introduced a new monetary policy committee and changed its organizational structure. Lastly, Finance Minister Robertson added house prices to the RBNZ’s monetary policy remit despite objections from Governor Orr.

The National Party is leading in opinion polls ahead of the October 14 elections. As such, there is a significant chance that the RBNZ will once again undergo major changes. While this should result in a more hawkish RBNZ stance in general, we do not think monetary policy should be a political football that is subject to changes with every election. Nor should monetary policy be scrutinized by the government. Willis also said that if the National Party wins, it would “quickly commission” an independent review of the RBNZ’s monetary policy response to the pandemic. The RBNZ has already conducted a review and another one would simply be overkill.

China reported official August PMIs. Manufacturing came in at 49.7 vs. 49.2 expected and 49.3 in July, while non-manufacturing came in at 51.0 vs. 51.2 expected and 51.5 in July. As a result, the composite rose two ticks to 51.3. Caixin reports its manufacturing PMI tomorrow and is expected to fall two ticks to 49.0. Its services and composite PMIs won’t be reported until next Tuesday, with services expected at 53.9 vs. 54.1 in July. Data out of China are likely to continue weakening as policymakers refrain from injecting significant stimulus, at least for now.

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