Dollar Firm as Eventful Week Begins

July 29, 2024

Win Thin

Global divergences will be spotlighted in this incredibly jam-packed week; the U.S. economy remains robust even as the rest of the world is struggling to grow; only U.S. data release is Dallas Fed manufacturing survey for July; Brazil reports June consolidated budget data
Chancellor of the Exchequer Reeves will outline the results of an audit of U.K. finances; U.K. CBI reported a soft distributive trade survey for July; Sweden reported weak Q2 GDP
New Zealand Finance Minister Willis spoke; yields in China continue to fall after last week’s surprise easing

The dollar is trading firms as an eventful week begins. DXY is trading higher for the first time since last Tuesday near 104.460 as markets await decisions from the Fed, BOJ, and BOE. The euro is trading lower near $1.0840, while sterling is trading lower near $1.2840 ahead of an expected BOE cut Thursday. The yen is trading flat near 153.90 ahead of an expected dovish hike from the BOJ Wednesday. While the Fed is expected to open the door for a September cut Wednesday, recent firmness in the U.S. data suggests the market is once again getting carried away with its pricing for aggressive easing (see below). Beyond just the U.S. story, we continue to believe that weaker data in many of the major economies will feed into more dovish central banks, underscoring that the divergence story remains in place and should continue to support the dollar.

AMERICAS

Global divergences will be spotlighted in this incredibly jam-packed week. While the FOMC is expected to open the door to a September cut, growth remains strong in the U.S. The “Goldilocks” economic backdrop of solid growth and modest disinflation suggests the Fed is unlikely to cut rates as much as currently priced in. The market is pricing nearly 75 bp of easing by year-end and nearly 150 bp of total easing over the next 12 months. If the soft landing scenario remains intact, such aggressive easing won’t be needed. Moreover, rising U.S. productivity can lead to low inflationary economic growth, higher real interest rates, and an appreciation in the greenback over the longer term.

The U.S. economy remains robust even as price pressures continue to ease slowly. Last week’s data (Q2 GDP, July S&P Global PMIs) largely surprised to the upside. Looking ahead, the Atlanta Fed’s GDPNow model’s initial estimate for Q3 growth came in at 2.8% SAAR and will be updated Thursday after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q3 growth at 2.7% SAAR and will be updated Friday. Its initial estimate for Q4 growth will come at the end of August. Bottom line: above trend growth means the Fed won’t cut rates aggressively.

Meanwhile, the rest of the world is struggling to grow. Japan’s economy remains soft and market pricing for BOJ tightening remains largely unchanged at 70 bp over the next three years. The yen will likely struggle to gain further upside momentum as we expect the BOJ to deliver a dovish hike Wednesday that does little to shift these dovish expectations. Elsewhere, sterling faces downside risks as the BOE is expected to start the easing cycle Thursday. Recent U.K. data suggest the recovery is running out of steam, with possible fiscal tightening on the horizon (see below). Lastly, eurozone CPI and GDP data this week should underscore the need for the ECB to cut rates more aggressively. This should limit the euro’s upside.

Only U.S. data release is Dallas Fed manufacturing survey for July. It is expected at -15.5 vs. -15.1 in June. Most of the surveys reported so far remain in contractionary territory. We’ll know more when ISM manufacturing PMI is reported Thursday.

Brazil reports June consolidated budget data. A primary deficit of -BRL39.5 bln is expected vs. -BRL63.9 bln in May. Last week, the central government primary deficit came in a bit larger than expected at -BRL38.8 bln. With fiscal policy remaining too loose, the central bank has most likely ended its easing cycle. COPOM meets Wednesday and is expected to keep rates steady at 10.5%. It’s messaging will be key, as the market is pricing in nearly 125 bp of tightening over the next six months.

EUROPE/MIDDLE EAST/AFRICA

Chancellor of the Exchequer Reeves will outline the results of an audit of U.K. finances. Reports suggest she will detail a previously hidden GBP20 bln funding shortfall for public services and will stress that “Before the election, I said we would face the worst inheritance since the Second World War. But upon my arrival at the Treasury three weeks ago, it became clear that there were things I did not know.” Reports also suggest this could pave the way for tax increases in the autumn budget. If so, tighter fiscal policy could reinforce the case for a looser BOE policy stance.

U.K. CBI reported a soft distributive trade survey for July. Total reported sales came in at -30 vs. 9 in June, while retailing reported sales came in at -43 vs. -24 in June. This comes after a very weak industrial trends survey last week and confirms our belief that the BOE is likely to start cutting rates this week. The market currently sees nearly 60% odds of a cut Thursday, up from 50% last week.

Sweden reported weak Q2 GDP. GDP came in at -0.8% q/q vs. last expected and -0.1% in Q1. Of note, June GDP came in at 0.9% m/m vs. a revised -0.1% (was 0.1%). Regardless, weak economic activity and the sharp slowdown in inflation in June underscore the Riksbank’s guidance that “the policy rate can be cut two or three times during the second half of the year.” The Riksbank’s next policy meeting is August 20 and a 25 bp cut to 3.5% is fully priced in. Indeed, three cuts by year-end are fully priced in, along with 35% odds of a fourth. The market is pricing in 150 bp of total easing over the next 12 months.

ASIA

New Zealand Finance Minister Willis spoke. She pointed out that with the current fiscal policy stance, “we’ve set up the conditions that should allow the Reserve Bank to cut rates.” The swaps market largely agrees as it is pricing in 66% odds of a rate cut at the next meeting August 14. We think the RBNZ can afford to wait until October 9 before easing, as non-tradeable CPI inflation remains sticky at 5.4% y/y in Q2. Three cuts by year-end are fully priced in, along with 175 bp of total easing over the next 12 months.

Yields in China continue to fall after last week’s surprise easing. The 10-year government bond yield traded at an all-time low of 2.15%, while the 30-year yield traded below 2.40% for the first time in nearly twenty years. Spreads to UST are near all-time lows and so yuan weakness is likely to resume in force after last week’s gains.

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