• U.S. inflation data remain in focus after yesterday’s CPI report; Fed tightening expectations shot up, giving the dollar a much-needed boost; U.S. yields continue to rise
  
• Eurozone reported weak July IP; the monthly U.K. data dump continues with August CPI; Sweden reported August CPI
  
• Reports suggest the BOJ conducted a so-called rate check in the FX market; the September 21-22 meeting is back in focus with USD/JPY trading near the cycle high; Japan reported firm July core machine orders; New Zealand reported Q2 current account data
  

The dollar is consolidating yesterday’s gains. After trading at a new low for this move near 107.68 yesterday, DXY reversed and traded as high as 110 before falling back to 109.313 currently. Just like that, we are looking at last week’s cycle high near 110.786. It was an outside up day for DXY that points to further gains ahead. EUR just narrowly missed an outside down day as yesterday's high fell short of the previous day's high. Still, we look for a test of the September 6 cycle low near $0.9865. Sterling had outside down day and is on track to test its September 7 cycle low near $1.1405. Lastly, USD/JPY tested 145 today before a BOJ rate check saw those gains reversed (see below). The repricing of Fed risks is likely to keep the dollar bid across the board near-term. As we said during this most recent dollar correction lower, nothing has really changed fundamentally and the global backdrop continues to favor the dollar and U.S. assets in general.

AMERICAS

U.S. inflation data remain in focus after yesterday’s CPI report. August PPI will be reported today. Headline is expected at 8.8% y/y vs. 9.8% in July, while core is expected at 7.0% y/y vs. 7.6% in July. Yesterday, CPI ran a little hot as headline came at 8.3% y/y vs. 8.1% expected and 8.5% in July, while core came in at 6.3% y/y vs. 6.1% expected and 5.9% in July. While this was still the second straight month of deceleration for headline from the 9.1% peak in June to the lowest since April, it’s a huge reminder that the Fed’s fight against inflation is nowhere close to being over.

Fed tightening expectations shot up, giving the dollar a much-needed boost. WIRP suggests nearly 35% odds of a 100 bp hike at next week's FOMC. One big bank has already come out with a 100 bp call and while we favor 75 bp, the risks are definitely tilted towards a bigger move. We think it would be very tempting for the Fed to hike 100 bp in order to underscore its inflation-fighting credentials and surprise the markets. Equities would tank but that's what the Fed wants. More importantly , the swaps market is now pricing in a terminal rate between 4.25-4.50%. There are no Fed speakers this week as the media blackout went into effect midnight Friday. It remains in place until Chair Powell’s post-decision press conference on September 21.

U.S. yields continue to rise. The 2-year yield traded at a new cycle high near 3.80%, while the 10-year yield traded near 3.46%, just slightly below the June 14 high near 3.50%. Of note, the real 10-year yield is trading near 0.99%, the highest since January 2019. This is due both to rising nominal yields as well as falling inflation expectations. For now, the market is giving the Fed a thumbs up in terms of its aggressive tightening. Yesterday, Treasury completed its big slug of coupon issuance this week with a $18 bln sale of 30-year bonds. There was strong demand the bid/cover ratio was 2.42 vs. 2.31 at the previous auction and indirect bidders took 72.1% vs. 70.6% at the previous auction. This comes after lukewarm interest in the 3- and 10-year auctions Monday.

EUROPE/MIDDLE EAST/AFRICA

Eurozone reported weak July IP. IP came in at -2.3% m/m vs. -1.1 expected and a revised 1.1% (was 0.7%) in June. As a result, the y/y fell to -2.4% vs. flat expected and a revised 2.2% (was 2.4%) in June. It’s clear that the weakness first seen in Germany has spread to the other large economies in the eurozone. Can the ECB hike as aggressively as the market believes? Of note, WIRP suggests around 80% odds of another 75 bp hike October 27, while the swaps market is pricing in 250 bp of tightening over the next 12 months that would see the deposit rate peak near 3.25%.

The monthly U.K. data dump continues. August CPI data was reported. Headline came in a tick lower than expected at 9.9% y/y, core came in a tick higher than expected at 6.3% y/y vs. 8.0% in July, and CPIH came in a tick lower than expected 8.6% y/y. Similar to what we saw in the U.S., headline is falling as energy prices fall but core is rising as price pressures become more broad-based. Bank of England meets next Thursday and is expected to hike rates 75 bp to 2.5%. WIRP suggests such a move is about 70% priced in, while the swaps market is pricing in 275 bp of tightening over the next 12 months that would see the policy rate peak near 4.5%.

Sweden reported August CPI. Headline came in at 9.8% y/y vs. 9.6% expected and 8.5% in July, CPIF came in at 9.0% y/y vs. 8.8% expected and 8.0% in July, and CPIF ex-energy came in at 6.8% y/y vs. 6.9% expected and 6.6% in July. WIRP suggests 40% odds of a 100 bp hike to 1.75% at the next policy meeting September 20. At the last meeting June 30, the bank said it expects the policy rate to be 2.0% by Q2 23. There are typically no updated macro forecasts or rate path at the September meetings but the June rate path is clearly outdated and so we expect a hawkish shift to be unveiled at the November 24 meeting that would move the Riksbank closer to market pricing. The swaps market is pricing in 275 bp of tightening over the next 12 months that would see the policy rate peak near 3.5%.

ASIA

Reports suggest the Bank of Japan conducted a so-called rate check in the FX market. With USDJPY testing the 145 level, the intent was clear. Finance Minister Suzuki said “If this kind of situation continues, we won’t rule out any options in responding,” adding that policymakers won’t give prior warning and that action will come swiftly. While some view a rate check as a precursor to actual FX intervention, we view it as a toothless maneuver that is just half a step up from jawboning. We know that Japan cannot run ultra-loose monetary policy without encouraging yen weakness as monetary policy divergences remain a key driver in FX. Indeed, the 2-year US-Japan differential has shot up to 385 bp, the highest since June 2007. With the BOJ on hold until 2023 at least, this gap should continue moving in the dollar's favor and eventually push USD/JPY past 145 to test the August 1998 high near 147.65.

The Bank of Japan meeting September 21-22 is back in focus with USD/JPY trading near the cycle high. While we expect this pair to resume its climb, markets may be reluctant to sell the yen ahead of that BOJ meeting on the off chance (very unlikely) that the bank does do some sort of pivot this month. We expect the bank to express concern about yen weakness but we do not think any concrete action will be taken.

Japan reported firm July core machine orders. Orders rose 5.3% m/m vs. -0.6% expected and 0.9% in June, which pushed the y/y rate up to 12.8% y/y vs. 6.6% expected and 6.5% in June. The economy continues to benefit from the reopening but domestic demand remains soft even as the external backdrop worsens. This is why the BOJ is reluctant to remove stimulus and risk triggering a huge move down in US/JPY.

New Zealand reported Q2 current account data. The deficit widened to-7.7% of GDP vs. -7.5% expected and a revised -8.8% (was -6.5%) in Q1. This is the widest since Q4 2008 and adds to the downward pressure on NZD. GDP data will be reported tomorrow, with growth expected at 1.0% q/q vs. -0.2% in Q1. After weak Q2 manufacturing activity and real retail sales were reported, we see downside risks to Q2 GDP. WIRP suggests a 50 bp hike to 3.5% October 5 is fully priced in, while the swaps market is pricing in 125 bp of tightening over the next 6 months that would see the policy rate peak near 4.25%, down from 4.5% at the start of last week.