- U.S. yields continue to rise; Fed tightening expectations remain elevated; August retail sales data were mixed; University of Michigan consumer sentiment will be closely watched; regional Fed manufacturing surveys for September have started off mixed
- U.K. reported weak August retail sales data; we would be remiss if we did not mention that today is the anniversary of Black Wednesday; ECB President Lagarde is sounding hawkish; Russia cut rates 50 bp to 7.5%, as expected
- Japan Finance Minister Suzuki continues to jawbone the yen; RBA Governor Lowe hinted at a pivot; China reported firm August IP and retail sales data
The dollar remains firm ahead of the weekend. DXY is up for the second straight day and trading just below 110. We look for a test of last week’s cycle high near 110.786. The euro remains heavy and is trading just below parity. We still look for a test of last week’s cycle low near $0.9865. Sterling is underperforming after weak retail sales data and traded near $1.1350, the lowest since 1985. Charts point to a test of the February 1985 all-time low near $1.0520. Lastly, USD/JPY is trading sideways near 143.25 as this week’s BOJ rate check continues to dampen the upward trajectory of this pair. Once next week’s BOJ meeting is out of the way, we expect yen weakness to resume. The repricing of Fed tightening 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. yields continue to rise. The 2-year yield traded at a new cycle high near 3.92%, while the 10-year yield traded near 3.48%, slightly below the June 14 high near 3.50%. The real 10-year yield rose above 1.0% for the first time since December 2018 and is on track to test he November 2018 cycle high near 1.15%. This generalized increase in U.S. yields should continue to support the dollar. Of note, the 3-month to 10-year curve remains positively sloped and so we are not yet ready to call for a recession in the U.S.
Fed tightening expectations remain elevated. WIRP suggests 25% odds of a 100 bp hike next Wednesday. While we favor 75 bp, we acknowledge risks of a hawkish surprise. With a 100 bp move, the Fed could send a very strong message to the markets that it is very serious about getting inflation back to target. Looking ahead, the swaps market is pricing in a terminal rate of 4.5%, up sharply in recent days and making new highs for this cycle.
August retail sales data were mixed. Headline came in at 0.3% m/m vs., -0.1% expected and a revised -0.4% (was flat) in July, while sales ex-autos came in at -0.3% m/m vs. flat expected and a revised flat (was 0.4%) in July. The so-called control group used for GDP calculations came in flat m/m vs. 0.5% expected and a revised 0.4% (was 0.8%) in July. Of note, the Atlanta Fed’s GDPNow model is tracking 0.5% SAAR growth for Q3, down from 1.3% previously. The next model update will be seen September 20.
September University of Michigan consumer sentiment will be closely watched. Headline is expected at 60.0 vs. 58.2 in August, driven by improvements in both current conditions and expectations to 59.4 and 59.0, respectively. Can the U.S. consumer remain strong? Household earnings are getting squeezed but the labor market remains strong and consumer confidence is recovering. Weekly claims came in at 213k yesterday, the lowest since late May. Lastly, 1-year inflation expectations are seen falling two ticks to 4.6%, while 5 to 10-year expectations are seen steady at 2.9%. July TIC data will also be reported.
Regional Fed manufacturing surveys for September have started off mixed. The Empire survey came in at -1.5 vs. -12.9 expected and -31.3 in August, while the Philly Fed survey came in at -9.9 vs. 2.3 expected and 6.2 in August. August IP was also reported yesterday and came in at -0.2% m/m vs. flat expected and a revised 0.5% (was 0.6%) in July. Other indicators suggest the manufacturing sector remains resilient and so we do not want to make too much of some regional weakness being seen.
EUROPE/MIDDLE EAST/AFRICA
U.K. reported weak August retail sales data. Headline sales fell-1.6% m/m vs. -0.5% expected and a revised 0.4% (was 0.3%) in July, while sales ex-auto fuel also fell -1.6% m/m vs. 0.4% in July. As a result, the y/y rates fell to -5.4% and -5.0%, respectively. The data confirm what we all know already, and that is the economy is sliding into recession. How long and how deep this downturn will be remains a great source of debate. Bank of England meets next Thursday and WIRP suggests only 20% odds of a 75 bp hike, down from 70% at the start of this week. Looking ahead, the swaps market is still pricing in 275 bp of tightening over the next 12 months that would see the policy rate peak near 4.5%.
We would be remiss if we did not mention that today is the anniversary of Black Wednesday. Thirty years ago, sterling was unceremoniously ejected from the Exchange Rate Mechanism. Sterling is marking the occasion by trading at its weakest level since 1985 near $1.1350. There is literally nothing in the charts until the February 1985 all-time low near $1.0520.
ECB President Lagarde is sounding hawkish. She said the bank must “absolutely” avoid second round effects of inflation on wages. Lagarde acknowledged that “We have more supply shock than demand shock, but we have both, so we’re obliged to act taking account of this complicated mix of supply and demand. So what we have to do as the central bank is we have to be focused on our price-stability target, which we’ve set at 2% over the medium-term. So we have to use all the monetary policy tools available to us to reach this target.” WIRP suggests another 75 bp hike October 27 is almost fully priced in while the swaps market is pricing in 200 bp of tightening over the next 12 months that would see the deposit rate peak near 2.75%, down from around 3.25% at the start of this week.
Russia central bank cut rates 50 bp to 7.5%, as expected. CPI rose 14.3% y/y in August vs. 15.1% in July, decelerating for the fourth straight month to the lowest since February but still well above the 4% target. The bank said it will monitor the economy for future rate decisions. At the last policy meeting July 22, the bank predicted that the policy rate would average between 7.4-8.0% from then until year-end and the rate is now at the bottom of that range. Further cuts may be difficult as the bank noted that a wider budget deficit may require tighter policy.
ASIA
Japan Finance Minister Suzuki continues to jawbone the yen. Repeating comments made earlier this week, he warned that policymakers won’t rule out any options if recent moves in exchange rates continue. Using boilerplate MOF language, Suzuki said it’s important for FX to move in line with fundamentals and that rapid moves are undesirable. He expressed concern about recent one-sided, excessive moves in the FX market and warned that policymakers will continue to closely monitor the FX market. The Bank of Japan meeting September 21-22 has taken on greater importance with this renewed focus on the yen. 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 next week. That said, all signs point to yet another dovish hold. Some concern about the weak yen will be expressed but we do not think the BOJ will exit stimulus until 2023 at the earliest.
RBA Governor Lowe hinted at a pivot. Testifying before Parliament, he noted that “At some point, it will be appropriate to slow the rate of increase in interest rates and the case for doing that becomes stronger as the level of interest rates increases.” Lowe added that the bank expects further hikes will be needed but “We are not on a pre-set path.” While this is simply stating the obvious, markets around the world are sensitive to any signs of a pivot. AUD is trading at new lows for this move near .6670. Key level to watch is .6465 as a break below would set up a test of the March 2020 low near .5510.
China reported firm August IP and retail sales data. IP came in at 4.2% y/y vs. 3.8% expected and actual in July, while sales came in at 5.4% y/y vs. 3.3% expected and 2.7% in July. While the improvements are welcome, we do not expect a sharp rebound given slowing global growth and modest domestic stimulus efforts. Indeed, it appears that IP was boosted by power generation during the heat wave while sales were boosted by low base effects. As long as policymakers rely on Covid Zero, the economy will be subject to waves of weakness. Today, USD/CNY followed USD/CNH yesterday and traded above 7 for the first time since July 2020. There's nothing magical about that level and I'd only point out that with the PBOC in easing mode, the monetary policy divergence argues for further yuan weakness. USD/CNY is on track to test 7.1775 and USD/CNH is on track to test 7.1965, both highs from May 2020.