Fed Chair Powell made some rare comments about the dollar; the U.S. yield curve is flattening but still nowhere near inverting; Fed tightening expectations have steadied but remain off the recent highs; Chicago PMI will be today’s highlight; May core PCE will be closely watched; Colombia is expected to hike rates 150 bp to 7.5%.
France reported June CPI data; ECB tightening expectations have softened; Germany reported some key data; BOE Governor Bailey did sterling no favors; the Riksbank hiked rates 50 bp to 0.75%, as expected
Japan reported weak May IP and housing starts data; China reported strong official June PMI readings

The dollar is building on its recent gains. DXY is trading at the highest since June 16 near 105.282 and the break above 104.883 sets up a test of the June high near 105.788. The euro is leading this move and is on track to test the June low near $1.0360. After that, we have to start talking about parity. The weakening trend in the yen has stalled today, with USD/JPY near 136.40 after trading at a new cycle high near 137 yesterday. With BOJ dovishness being maintained, we still believe the pair will eventually test the August 1998 high near 147.65. Sterling is on track to test of the June low near $1.1935. After that is the March 2020 low near $1.1410. When all is said and done, we believe the U.S. economy will prove to be more resilient than the rest of DM and so we look for continued dollar gains.

AMERICAS

Fed Chair Powell made some rare comments about the dollar yesterday. He noted that the dollar has been strong, which tends to be disinflationary. Powell added that the dollar is just another financial condition to the Fed but acknowledged that it doesn’t have responsibility for its level. While that is certainly true as Treasury runs dollar policy, the natural by-product of a monetary tightening cycle is a stronger currency. When all is said and done, ongoing dollar strength is unlikely to raise any concerns at the Fed.

The U.S. yield curve is flattening but still nowhere near inverting. Some portions of the curve have inverted but faithful readers will know that we favor the 3-month to 10-year curve as the best recession signal. At 136 bp, it is the flattest since December but still far from inverting. This suggests very low odds of recession over the next 12 months. However, the odds are clearly rising.

Fed tightening expectations have steadied but remain off the recent highs. WIRP suggests a 75 bp hike at the next meeting July 27 is nearly 75% priced in, down from 85% at the start of this week, while 50 bp hikes at the subsequent meetings September 21 and November 2 are no longer fully priced in. Looking ahead, the swaps market is pricing in 175-200 bp of tightening over the next 12 months that would see the policy rate peak near 3.50%, down from nearly 4.0% at the start of last week.

Chicago PMI will be today’s highlight. It is expected at 58.0 vs. 60.3 in May. ISM manufacturing PMI will be reported Friday and is expected at 54.7 vs. 56.1 in May. Keep an eye on employment and prices paid, which stood at 49.6 and 82.2 in May, respectively. There are downside risks to this week’s PMI readings after S&P Global last week reported weak flash PMI readings for June. Manufacturing came in at 52.4 vs. 56.0 expected and 57.0 in May, services came in at 51.6 vs. 53.3 expected and 53.4 in May, and the composite came in at 51.2 vs. 53.0 expected and 53.6 in May. That composite was the lowest since July 2020 and has fed into U.S. recession fears.

May core PCE will be closely watched. It is expected to fall a tick to 4.8% y/y. If so, it would be the third straight month of deceleration from the 5.3% peak in February and would help take some pressure off of the Fed. That said, it is nowhere near the 2% target and so the Fed is likely to continue hiking aggressively in H2. Personal income and spending will be reported at the same time and are expected to rise 0.5% m/m and 0.4% m/m, respectively. Weekly jobless claims will also be reported.

Colombia central bank is expected to hike rates 150 bp to 7.5%. However, several analysts polled by Bloomberg look for smaller 75-125 bp moves. CPI rose 9.07% y/y in May, the first deceleration since March 2021 but still well above the 2-4% target range. AS such, we lean towards 150 bp today. The swaps market is pricing in 450 bp of tightening over the next 12 months that would see the policy rate peak near 10.50%.

EUROPE/MIDDLE EAST/AFRICA

France reported June CPI data. Its EU Harmonized inflation came in as expected at 6.5% y/y vs. 5.8% in May. Italy reports tomorrow and its EU Harmonized inflation is expected at 8.0% y/y vs. 7.3% in May. Yesterday, Spain surprised to the upside while Germany surprised to the downside. Eurozone also reports CPI tomorrow. Headline is expected at 8.5% y/y vvs.8.1% in May, while core is expected at 3.9% y/y vs. 3.8% in May. Despite rising inflation, the ECB’s task is made all the more difficult by fragmentation risks.

ECB tightening expectations have softened. WIRP suggests a 25 bp hike July 21 is fully priced in. A 50 bp hike is fully priced in for the next meeting September 8 but not for the subsequent meetings on October 27 and December 15. As a result, the deposit rate is now seen slightly below 1.0% at year-end vs. 1.25% at the start of last week. Looking ahead, the swaps market is now pricing in 225 bp of tightening over the next 24 months that would see the deposit rate peak near 1.75% vs. 2.25% at the start of last week.

Germany reported some key data. June unemployment rose 133k vs. -5.0k expected and a revised -5.0k (was -4.0k) in May. As a result, the unemployment rate jumped to 5.3% vs. 5.0% expected and actual in May. The rise was reportedly due to the influx of Ukrainian refugees, which were included in those searching for work. Germany also reported May retail sales, which came in at 0.6% m/m vs. 0.5% expected and -5.4% in April. Elsewhere, France reported May consumer spending, which came in at 0.7% m/m vs. 0.2% expected and a revised -0.7% (was -0.4%) in April.

Bank of England Governor Bailey did sterling no favors. Yesterday, he said the pound was “one of the many influences on inflation” and added that he was not surprised by its recent weakness. Bailey acknowledged that “The U.K. economy is probably weakening rather earlier and somewhat more than others. That’s been somewhat evident now for a few months.” This stands in contrast to MP Mel Stride, a former Treasury minister who leads the Treasury Committee in the House of Commons, He warned that sterling weakness “is something we should be concerned about” as “the most worrying thing is the cost-push inflation on imports.” Bank of England expectations remain steady. WIRP suggests a 50 bp hike move at the August 4 meeting is nearly 90% priced in vs. 75% at the start of this week and 95% at the start of last week. Looking ahead, the swaps market is still pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak near 3.25%, down from nearly 3.75% at the start of last week.

The Riksbank hiked rates 50 bp to 0.75%, as expected. WIRP suggested nearly 50% odds of a 75 bp move. Of note, Governor Ingves said that if it becomes necessary, the bank will hike by 75 bp. He downplayed risks of an intra-meeting move, noting “When we have done that in the past it has typically not been only due to monetary policy but because of large events such as the global financial crisis or the pandemic.” The bank said it expects the policy rate to be close to 2.0% at the start of 2023 as the updated rate path implies another 25 bp hike to 0.75% in Q3 22 followed by five more hikes to 2.0% by Q2 23, with small risks of another hike by Q2 25. Ingves said “At this point our basic assumption is that hiking the rate to somewhere around 2%” will move inflation back to the 2% inflation target “but if that isn’t enough we will continue increasing the policy rate further until we get inflation down to our target.” The swaps market has a different view and is pricing in 225 bp of tightening over the next 12 months that would see the policy rate peak near 3.0% vs. 2.5% right after the April hike. If inflation remains high, the Riksbank’s expected rate path should move even closer to market pricing.

ASIA

Japan reported weak May IP and housing starts data. IP was expected at -0.3% m/m but instead plunged -7.2% vs. -1.5% in April. As a result, the y/y came in at -2.8% y/y vs. 4.2% expected and -4.9% in April. Elsewhere, starts came in at -4.3% y/y vs. 1.6% expected and a revised 2.4% (was 2.2%) in April. This was the first negative reading since February 2021. Recent weakness in some of the real sector data is likely to reinforce the Bank of Japan’s resolve to maintain its accommodative stance for the foreseeable future. Next policy meeting is July 20-21 and no change is expected then.

China reported strong official June PMI readings. Manufacturing came in at 50.2 vs. 50.5 expected and 49.6 in May, while non-manufacturing came in at 54.7 vs. 50.5 expected and 47.8 in May. As a result, the composite PMI rose sharply to 54.1 vs. 48.4 in May, the highest since May 2021. Caixin manufacturing PMI will be reported tomorrow and is expected at 50.2 vs. 48.1 in May. The economy should continue to recover as restrictions are eased, but we’ve already seen some quickly reversed when the virus numbers rise. As a result, the recovery is likely to be uneven and spotty.