Dollar Consolidates Ahead of CPI Data

September 14, 2021
  • August CPI will be closely watched; from what we can tell, supply bottlenecks will remain in place far longer than the market or the Fed expects
  • U.K. reported firm labor market data; next BOE decision is due September 23
  • Polls suggest vaccine czar Kono has quickly consolidated support for the LDP leadership; RBA Governor Lowe pushed back against market expectations for rate hikes; sentiment continues to worsen for Chinese assets as property giant Evergrande revealed the scale of its debt and more Covid cases lead to further restrictions

The dollar is consolidating its recent gains. DXY is flat today after two straight up days and is trading near 92.618. A break above 93.048 is needed to set up a test of the August 20 high near 93.729. Similarly, the euro remains heavy near $1.18 and a break below $1.1760 would set up a test of the August 20 low near $1.1665. Sterling is holding up better near $1.3875 on firm labor market data (see below), while USD/JPY has been able to stay above 110 after selling took it as low as 109.60 last week. We remain positive on the dollar but acknowledge that a sustained rally will depend largely on the economic data in the coming days and weeks. It was a mixed session for APAC equities with the Nikkei set for its highest close since 1990 but the Hang Seng and Shanghai Comp both -1% on negative China headlines about Evergrande and Covid (see below).

AMERICAS

August CPI will be closely watched. Headline is expected to ease a tick to 5.3% y/y, while core is also expected to ease a tick to 4.2% y/y. We see some upside risks here since last week, PPI came in higher than expected, with headline rising 8.3% y/y vs. 7.8% in July and core rising 6.7% y/y vs. 6.2% in July. Furthermore, the Fed Beige Book noted that more businesses across the nation were finding it easier to pass through higher costs to their customers.

From what we can tell, supply bottlenecks will remain in place far longer than the market or the Fed expects. One then has to question what “transitory” really means. To quote a well-known Spanish swordsman, “You keep using that word. I do not think that word means what you think it means.” Between the more than transitory inflation that the U.S. is experiencing and the potential financial stability risks of ultra-loose policy building, we fully understand why the Fed hawks are pushing to take the foot off the gas pedal. Rate hikes are of course a different story and that will be determined over the course of 2022. However, we believe the Fed is fully prepared to start tapering before year-end.

EUROPE/MIDDLE EAST/AFRICA

U.K. reported firm labor market data. Unemployment for the three months ending in July fell a tick as expected to 4.6%, driven by a 183k (199k expected) rise in employment during that same period. Average weekly earnings came in a tick higher than expected at 8.3% y/y but still slowed from 8,8% in June. Lastly, jobless claims fell -58.6k in August vs. a revised -48.9k (was -7.8k) in July, suggest the improvement in the labor market continued ahead of the expiry of the jobs furlough program this month. Indeed, other data from the Office for National Statistics showed that job openings jumped to 1.03 mln, the first time they’ve risen above 1 mln. Last week’s data for July was very disappointing and so this week’s data have taken on greater importance. Will higher wages translate into higher inflation? August CPI will be reported tomorrow and will be another piece of the puzzle.

Next Bank of England decision is due September 23. While we expect another dovish hold in light of the softer data, there is a slight risk of a surprise hawkish tilt after Governor Bailey recently revealed that the MPC was split 4-4 at the August meeting as to whether there was clear evidence that the bank would achieve its 2% target “sustainably.” Of note, the inflation forecasts from the August 5 decision were 4.0% (vs. 2.5% in May) in 2021, 2.5% (2.0%) in 2022, and 2.0% (2.0%) in 2023. To us, these forecasts suggest no hurry to hike and no need to hike aggressively. However, the development of the labor market and wage pressures will be key. Updated BOE forecasts won’t be made until the November 4 decision. 2024 will be added to the forecast horizon then and will be very important components of the bank’s forward guidance.

ASIA

Polls suggest vaccine czar Kono has quickly consolidated support for the LDP leadership. Reports suggest several ministers plan to back him, leading another potential candidate Ishiba to stay out of the race and support Kono instead. Kono has hinted that hf he wins, Ishiba could be offered a top cabinet post. Public opinion polls suggest Kono is the most popular option, which will surely color the LDP leadership vote September 29. Whoever wins, we can expect another fiscal package ahead of the fall elections. For now, the BOJ is on hold.

RBA Governor Lowe pushed back against market expectations for rate hikes.  Current pricing suggests lift-off by late 2022 but Lowe noted "These expectations are difficult to reconcile. I find it difficult to understand why rate rises are being priced in next year or early 2023," he said in a speech to market economists. While policy rates might be increased in other countries over this timeframe, our wage and inflation experience is quite different.” Lowe also downplayed the notion that it would hike to cool off the housing markets, noting "I want to be clear that this is not on our agenda. While it is true that higher interest rates would, all else equal, see lower housing prices, they would also mean fewer jobs and lower wages growth. This is a poor trade-off in the current circumstances." Instead, Lowe would rely on regulatory steps. Overall, Lowe’s comments reinforce the bank’s current forward guidance that it won’t hike rates until 2024.

The RBA is clearly staking out a dovish stance that’s quite different from the RBNZ. Taken in conjunction with the RBA’s decision last week to delay its next QE review until February, the RBA is signaling that it is in no rush to remove accommodation. No wonder that AUD has been underperforming NZD of late, as the AUD/NZD cross is making new lows for this cycle near 1.031 today. With the RBNZ set to start hiking rates next month and likely to follow up with several more quite quickly, the cross is likely to test the March 2020 low just below 1.0.

Sentiment continues to worsen for Chinese assets as property giant Evergrande revealed the scale of its debt and more Covid cases lead to further restrictions. On the latter, the city of Xiamen (4.5 mln inhabitants) went into lockdown due to 12 new cases of Delta variant. In addition, some villages and residential compounds in the Fujian province will also be closed off. On the Evergrande situation, Bloomberg reports growing protests by retail investors. The protests are in part led by investors in the group’s wealth management products (WMP) asking the government to step in for a bail out. The problem here is the obvious one: the scale of Evergrande and the moral hazard precedent that a bailout would create. We don’t have any insights into how this situation will be resolved, but the good news is that this situation was well understood by investors. Chinese equities continue to underperform both the broad EM MSCI index and G10 indices by a large margin with the CSI300 down almost 6% on the year.

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