Dollar Builds on Recent Gains

August 16, 2022

Win Thin

Markets are in an uneasy calm; July IP will be the data highlight; Canada highlight will be July CPI data
German August ZEW consumer survey was weak; U.K. reported labor market data; Israel reported strong Q2 GDP data
RBA minutes were released; China is suffering from a heat wave that is impacting the economy

The dollar remains bid as markets await fresh drivers. DXY is up for the third straight day and is trading near 106.90 currently. The euro remains heavy and is currently trading near $1.0130. A break below $1.0110 would set up a test of the July 14 cycle low near $0.9950. Sterling is currently trading near $1.2020 and a break below $1.1965 would set up a test of the July 14 low near $1.1760. USD/JPY is inching higher to trade near 134.25, the highest since August 10. A clean break above 134.10 would set up a test of the August 8 high near 135.60. We maintain our strong dollar call as the dollar smile seems intact. Once this risk-off period ends, the dollar should still benefit from the relatively strong U.S. economic outlook.

AMERICAS

Markets are in an uneasy calm. Asian equity markets were mostly lower, while European markets are up modestly and U.S. equity futures are down modestly. U.S. Treasury yields are steady while the dollar continues to gain. Commodity prices are lower, with oil, copper, and iron ore all down modestly on the day. At this point, markets are likely waiting for the other shoe to drop after China’s data miss and surprise rate cut yesterday. As we’ve noted before, equity markets had gotten too complacent about the worsening global macro backdrop and must now reprice those risks. Global growth is slowing significantly even as central banks continue to tighten monetary policy. With inflation still high, there will be no pivot anytime soon. Who will ride to the rescue?

July IP will be the data highlight. It is expected at 0.3% m/m vs. -0.2% in June. July building permits and housing starts will also be reported and are expected at -3.3% m/m and -2.1% m/m, respectively. The Atlanta Fed’s GDPNow model is currently tracking 2.5% SAAR growth for Q3. However, it’s early on and so each data point can lead to big swings in the estimate. An update to the model will be released today after the data. Of note, the regional Fed manufacturing surveys started rolling out with the Empire survey yesterday and it wasn’t pretty. Headline fell to -31.3 vs. 5.0 expected and 11.1 in July.

Canada highlight will be July CPI data. Headline CPI is expected at 7.6% y/y vs. 8.1% in June, while core common is expected at 4.7% y/y vs. 4.6% in June. June manufacturing and wholesale trade sales as well as July existing home sales will be reported Monday. July housing starts will be reported Tuesday. Bank of Canada meets September 7 and a 50 bp hike is fully priced in, with nearly 45% odds of a 75 bp move. The swaps market is pricing in 100 bp of tightening over the next 6 months that would see the policy rate peak near 3.5%.

EUROPE/MIDDLE EAST/AFRICA

German August ZEW consumer survey was weak. Expectations came in at -55.3 vs. -52.7 expected and -53.8 in July, while current situation came in at -47.6 vs. -49.0 expected and -45.8 in July. ZEW noted that “The still high inflation rates and the expected additional costs for heating and energy lead to a decrease in profit expectations for the private consumption sector.” August IFO business climate survey and September GfK consumer confidence will be reported next week, both of which have been trending lower. ECB tightening expectations have eased a bit. WIRP suggests a 50 bp hike is about 70% priced in for September 8. The swaps market is pricing in 125-150 bp of tightening over the next 12 months that would see the deposit rate peak between 1.25-1.5%.

U.K. reported labor market data. Employment rose 160k in the three months through June vs. 268k expected, while the unemployment rate remained steady at 3.8%. Average weekly earnings slowed to 5.1% y/y during the same period vs. 4.5% expected and a revised 6.4% (was 6.2%) previously. Real wages fell -3% during the same period, the most since the series began in 2001, as rising inflation and slowing nominal wage gains are clearly hurting household income. Expect consumption to continue weakening in the coming months. Of note, job vacancies for the three months through July fell 19.8k, the first drop since August 2020 and possibly signaling weaker labor market conditions ahead. Meanwhile, WIRP suggests a 50 bp hike September 15 is nearly 85% priced in. The swaps market is pricing in 150 bp of tightening over the next 12 months that would see the policy rate peak near 3.25%.

Israel reported strong Q2 GDP data. Annualized growth came in at 6.8% vs. 2.2% expected and -1.8% in Q1. Yesterday, July CPI also ran hot. Headline came in at 5.2% y/y vs. 4.6% expected and 4.4% in June. It was the highest since October 2008 and further above the 1-3% target range. The central bank last hiked rates 50 bp to 1.25% July 4, the first 50 bp hike since 2011. The bank noted then that “The Israeli economy is recording strong growth, accompanied by a tight labor market and an increase in the inflation environment.” It also stopped referring to the tightening cycle as “gradual” and sees the policy rate at 2.75% in Q2 2023. Of note, the swaps market sees the policy rate peaking near 2.0% over the next 6 months, which seems too dovish. Next meeting is August 22 and another 50 bp hike is expected, with risks of a hawkish surprise.

ASIA

RBA minutes were released. Recall that the bank hiked rates 50 bp to 1.85%, as expected. The minutes show that “The board expects to take further steps in the process of normalizing monetary conditions over the months ahead, but it is not on a pre-set path It is seeking to do this in a way that keeps the economy on an even keel. The path to achieve this balance is a narrow one and subject to considerable uncertainty.” As per the decision, “Members noted that inflation was expected to peak later in 2022 and then decline back to the top of the2 to 3 per cent target range by the end of 2024. The expected moderation in inflation reflected the ongoing resolution of global supply-side problems, the stabilisation of commodity prices, and the impact of rising interest rates in Australia and overseas.” As a result of the bank’s messaging, WIRP now suggests only 40% odds of a 50 bp hike at the next meeting September 6. Looking ahead, the swaps market is pricing in 180 bp of tightening over the next 12 months that would see the policy rate peak near 3.65%.

China is suffering from a heat wave that is impacting the economy. Sichuan province announced at the start of this week that factories in 19 cities and prefectures would halt all operations until Saturday in order to preserve electricity for "use by the people." Other areas across China's southern region have also ordered electricity to be prioritized to run air conditioners rather than factories. Reports suggest this is China’s worst heat wave in six decades. The National Development and Reform Commission said China is having to rely more on coal for power generation as the heat wave and drought were significantly reducing the country’s hydroelectric power output. This is yet another headwind for the economy and PMI readings are likely to show significant deterioration in August.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2022. All rights reserved.