Central Banks Dominate Week

July 29, 2024

Central Banks Dominate Week

  • The Fed is expected to stand pat Wednesday but lay the groundwork for a September rate cut.
  • We anticipate the Bank of Japan (BOJ) to deliver a dovish hike Wednesday.
  • Our base case is for the Bank of England (BOE) to start easing Thursday.

USD is trading on the defensive against all major currencies within last week’s narrow range. Stocks markets in Asia are up while US and European equity futures are extending Friday’s gains. Stocks will largely take their cue this week from the quarterly earnings report of Microsoft (Tuesday), Meta (Wednesday), Apple (Thursday), and Amazon (Thursday).

USD will likely trade in a more volatile range this week. The FOMC is expected to keep the fed funds rate on hold but open the door for a September cut (Wednesday). The swaps market has more than fully priced-in a 25bps rate cut in September. Meanwhile, the US July non-farm payrolls report (Friday) will remain consistent with a labor market coming into better alignment. The Dallas Fed July manufacturing index is today’s highlight (3:30pm London).

Beyond the short-term, we remain bullish USD. The “Goldilocks” US economic backdrop of solid growth and modest disinflation suggests the Fed is unlikely to cut the funds rate as much as is currently priced-in. Fed funds futures are pricing almost three cuts by December 2024 and a total of roughly 150bps of easing over the next 12 months. Moreover, rising US productivity can lead to low inflationary economic growth, higher real interest rates and an appreciation in the currency over the longer term. US Q2 productivity data is reported Thursday.

JPY will struggle to gain further upside momentum as we anticipate the BOJ to deliver a dovish hike (Wednesday). The swaps market implies about 60% odds of a 10bps rate hike while only 30% of analysts polled by Bloomberg anticipate a rate increase. Attention will also turn to the BOJ’s updated macro forecasts and the planned reduction of its JGB purchase amount.

We expect the BOJ to lift the policy rate target 10bps to 0.10-0.20% but warn that policy settings will remain easy for the foreseeable futures. Japan underlying inflation is in a firm downtrend, and negative real cash earnings points to ongoing weakness in consumption spending activity. The BOJ is also expected to halve its JGB purchases in the coming years to ¥3 trillion.

GBP faces downside risks this week. Our base case is for the BOE to start easing Thursday because UK headline CPI inflation has been at the BOE’s 2% target the last two months. The swaps market implies 50% odds of a 25bps rate cut while most analysts polled by Bloomberg anticipate a cut.

Granted, UK services CPI inflation is still running high at 5.7% y/y but forward-looking indicators point to a sharp slowdown in H2. In July, the CBI industrial trends survey showed selling prices plunged to the lowest level since December 2020 while the PMI services input and output cost inflation were the softest in more than three years.

Today, Chancellor of the Exchequer Rachel Reeves will outline the results of an audit of the state of Britain’s finances. She’s expected to detail a near £20 billion funding shortfall for public services that could pave the way for tax increases this year. If so, tighter fiscal policy could reinforce the case for a looser BOE policy stance.

SEK ignored Sweden’s mixed GDP data. The real GDP indicator unexpectedly plunged -0.8% q/q (consensus: 0%) in Q2 weighed down by weak figures in April after contracting -0.1% in Q1. However, in June the real GDP indicator increased 0.9% m/m. Regardless, weak economic activity and the sharp slowdown in inflation in June underscore the Riksbank’s guidance that “the policy rate can be cut two or three times during the second half of the year.” The Riksbank’s next policy meeting is August 20.

NZD/USD is trading heavy under 0.5900. New Zealand Finance Minister Nicola Willis pointed out this morning “we’ve set up the conditions that should allow the Reserve Bank to cut rates.” The swaps market implies over 60% probability of an RBNZ rate cut at the next August 14 meeting. We think the RBNZ can afford to wait for October before slashing rates because non-tradeable CPI inflation remains sticky. In Q2, non-tradeable CPI rose 0.9% q/q which was higher than the RBNZ 0.8% q/q forecast.

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