Dollar Ends Week on a Firm Note

July 23, 2021
  • Market expectations for Fed policy continue to shift ahead of next week’s FOMC meeting; weekly initial jobless claims were disappointing; Markit preliminary July PMI readings will be reported; Canada reports May retail sales data; Brazil reports mid-July IPCA inflation
  • ECB delivered a dovish hold but markets were still a bit disappointed; eurozone preliminary July PMI readings were reported; U.K. reported mixed data; Russia hiked rates 100 bp to 6.5%
  • Australia reported preliminary July PMI readings; China said it is closely monitoring risks from any Fed policy changes

The dollar is ending a good week on a solid note. DXY is trading just below 93 and is up two straight days and six of the past seven. Further gains are expected and it should eventually test the March 31 high near 93.437. The euro remains heavy after the ECB decision (see below) and the clean break below $1.18 sets up a test of the March 31 low near $1.1705. Sterling is having trouble breaking back above $1.38 as economic uncertainty picks up (see below). Despite this recent bounce, we continue to look for a test of the February low near $1.3565. USD/JPY continues to edge further above 110 as risk off sentiment ebbs, trading at the highest level since July 14 near 110.50. A break above 110.65 is needed to set up a test of the July 2 high near 111.65.


Market expectations for Fed policy continue to shift ahead of next week’s FOMC meeting. The latest Bloomberg poll of 51 economists shows most respondents expect tapering in early 2022 and will be weighted more towards MBS. Three quarters expect an early tapering signal either at the August 26-28 Jackson Hole Symposium or the September 21-22 FOMC meeting. Half see a formal announcement at the December FOMC meeting, while nearly three quarters see actual tapering in Q1 2022. Most expect tapering to last 10-12 months, which would see it end in early 2023. After that, most respondents see two 25 bp hikes in 2023, followed by thee more in 2024 that would take the ceiling for the Fed Funds rate up to 1.5% from 0.25% currently.

This consensus timeline is close to what we have long expected. Much will depend on the data but if we had to weight the risks, it would be that tapering happens sooner rather than what the market expects. This is because we remain very optimistic about the U.S. economic outlook and see heightened inflation risks ahead. We see a hawkish hold at next week’s FOMC meeting as the Fed continue to tiptoe down the path to tapering. A mention of tapering is possible in the official statement. This ongoing central bank divergence is central to our strong dollar call for H2.

Weekly initial jobless claims were disappointing. Initial claims came in at 419k vs. 350k expected and a revised 368k (was 360k) the previous week. This was the highest since mid-May and are especially disappointing as they are for the BLS survey week containing the 12th of the month. Continuing claims are reported with a one-week lag and came in at 3.236 mln vs. 3.1 mln expected and a revised 3.265 mln (was 3.241mln) the previous week. Unfortunately, the claims data underscore ongoing unevenness in the labor market recovery. Current consensus for July NFP is currently 750k vs. 850k in June.

Markit preliminary July PMI readings will be reported. Manufacturing is expected at 62.0 vs. 62.1 in June, while service is expected at 64.5 vs. 64.6 in June. Of note, July Kansas City Fed manufacturing index came in yesterday at 30 vs. 25 expected and 27 in June.

Canada reports May retail sales data. Headline sales are expected to fall -3.0% m/m vs. -5.7% in April, while sales ex-autos are expected to fall -1.5% m/m vs. -7.2% in April. Last week, the Bank of Canada delivered another round of tapering. However, it stressed that future tapering will depend on the bank’s assessment of the “strength and durability” of the economic recovery. The bank also updated its inflation forecasts to 3.0% (2.3% previously) for 2021, 2.4% (1.9% previously) for 2022, and 2.2% (2.3% previously) for 2023.

Brazil reports mid-July IPCA inflation. Headline inflation is expected at 8.51% y/y vs. 8.13% in mid-June. If so, it would be the highest since August 2016 and further above the 2.25-5.25% target range. Next COPOM meeting is August 4 and a 75 bp hike to 5.0% is expected. There is some chance of a 100 bp hike but for now, we think it sticks with the current 75 bp pace.


The ECB delivered a dovish hold but markets were still a bit disappointed. All rates and QE programs were kept unchanged. However, the forward guidance was changed to reflect the changes made in the recently completed strategy review. The ECB said it is committed to running persistently accommodative policy. It stressed that it won't increase interest rates until it sees inflation near its 2% target and it appears likely to remain there. The ECB added that this "may also imply a transitory period in which inflation is moderately above target." Of note, the June macro forecasts sees inflation at 1.5% in 2022 and 1,4% in 2023, which is the end of its current forecast horizon. That means given the new criteria, a hike is very unlikely before 2024 and perhaps even 2025. New forecasts will be unveiled at the September 9 meeting. 2024 will be added to the forecast horizon with forecasts at the December 16 meeting and will be another element of the new forward guidance.

The ECB also said that its PEPP can be recalibrated if required. However, the bank noted that it may not need to use all of the PEPP envelope or it may need to increase it. While this is mixed messaging, we know this is required to satisfy both the hawks and the doves at the ECB. While this is nothing truly earth-shattering, the potential change to the PEPP size is noteworthy. In her press conference, Madame Lagarde said that the risks to the outlook were broadly balanced. She added that while weak wages and euro strength will lead to subdued prices, underlying price pressures will increase gradually. All in all, the ECB delivered what was largely expected but we think the market is a bit disappointed that stronger measures weren't announced. That may come at the September meeting, when new forecasts will be released. We think the fundamental backdrop still favors a weaker euro.

Eurozone preliminary July PMI readings were reported. Headline manufacturing fell to 62.6 vs. 62.5 expected and 63.4 in June, while services rose to 60.4 vs. 59.3 expected and 58.3 in June. This dragged the composite higher to 60.6 vs. 60.0 expected and 59.5 in June. Germany’s services PMI rose to 62.2 from 57.5 in June, while the German composite rose to 62.5 from 60.1 in June. French services PMI fell to 57.0 from 57.8 in June, while the French composite fell to 56.8 from 57.4 in June.

The U.K. reported mixed data. Headline sales rose 0.5% m/m vs. -0.1% expected and a revised -1.3% (was -1.4%) in May, while sales ex-auto fuel rose 0.3% m/m vs. 0.1% expected and a revised -2.0% (was -2.1%) in May. There is some talk that the European soccer tournament led to a celebratory mood that boosted spending. Preliminary July PMI readings were also reported and suggest some softness ahead. Headline manufacturing fell to 60.4 vs. 62.4 expected and 63.9 in June, while services fell to 57.8 vs. 61.5 expected and 62.4 in June. This dragged the composite down to 57.7 vs. 61.5 expected and 62.2 in June. This is the lowest composite reading since March but remains relatively high from an historical standpoint. The impact of this past Monday’s Freedom Day came too late to be picked up fully in this preliminary reading and so we expect some improvement in the final readings due out the first week of August. Next BOE meeting is August 5 and a dovish hold is expected as we enter a period of heightened uncertainty.

Central Bank of Russia hiked rates 100 bp to 6.5%, as expected. The bank boosted its growth forecast for this year to 4.0-4.5% vs. 3.0-4.0% previously, and boosted its inflation forecast for this year to 5.7-6.2% from 4.7-5.2% previously. However, it sees inflation moderating next year to 4.0-4.5%. the bank said risks remain “significantly pro-inflationary” and that monetary conditions remain accommodative. It said it will consider another hike at one of its next meetings, which are September 10 and October 22. We cannot rule out more hikes in H2 but much will depend on the data and oil prices.


Australia reported preliminary July PMI readings. Manufacturing fell to 56.8 from 58.6 in June and services plunged to 44.2 from 56,8 in June, dragging the composite down to 45.2 from 56.7 in June. This was the lowest composite reading since May 2020, though far above the trough of 21.7 seen in April 2020. While lockdowns were expected to take toll on the economy, the weakness seen so far in July is a wake-up call for policymakers. Those lockdowns are persisting as we move into August and so there are rising risks to the recovery. No wonder the RBA minutes tilted dovish, acknowledging that QE could be adjusted up or down depending on the circumstances. Next RBA meeting is August 3 and another dovish hold is expected as policymakers watch to see how the recent lockdowns continue to impact growth in H2.

China’s State Administration of Foreign Exchange said it is closely monitoring risks from any Fed policy changes. It stressed that it is well prepared for the worst situation. SAFE official noted that the yuan was more stable than other EM currencies so far this year, adding that its fluctuations reflected uncertainties I global markets and also showed that the yuan is becoming more market-driven. We believe most EM policymakers, not just China, are watching developments in the U.S. very closely. While the bond market has so far avoided a taper tantrum as the Fed moves down that path, we know that inflection points in global liquidity will impact EM directly in terms of investment flows. That said, we are confident that China has the tools to address any sort of Fed-related turbulence.

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