Dollar Firm as FOMC Meeting Begins

July 26, 2022

Win Thin

The two-day FOMC starts today and the Fed is widely expected to hike rates 75 bp to 2.50%; June Chicago Fed NAI is concerning; regional Fed manufacturing surveys for July continue rolling out; Brazil reports mid-July IPCA inflation
Russia announced plans to cut gas flow through the Nord Stream pipeline; the eurozone was already weakening and now the threat of gas shortages has risen dramatically; U.K. CBI released the results of its July distributive trades survey; Hungary is expected to hike the base rate 100 bp to 10.75%.
Japan’s Cabinet Office raised its monthly economic assessment in for the first time in three months; the RBNZ is reviewing its monetary policy response to the pandemic; Korea reported firm Q2 GDP data

The dollar is getting traction ahead of the FOMC meeting. DXY is up for the first time after three straight down days and trading back above 107. Despite the ECB’s hawkish surprise last week, the euro remains unable to make much headway above $1.02. Eurozone growth risks have risen sharply as Russia announced another cut in natural gas shipments (see below), which will make it difficult for the ECB to hike aggressively. USD/JPY is creeping higher to trade near 136.50, up from last week’s low near 135.55 but still well below last week’s high near 138.90. Sterling is trading back below $1.20 after failing to make a clean break above $1.21 as the economic data continue to weaken (see below). We are not yet ready to change our strong dollar call. Yes, the U.S. economic data have been weakening but we do not think a recession is imminent. When all is said and done, we believe the U.S. economy remains the most resilient. However, we expect a period of consolidation ahead for the dollar until the U.S. economic outlook becomes clearer.

AMERICAS

The two-day FOMC starts today and the Fed is widely expected to hike rates 75 bp to 2.50%. WIRP suggests only around 15% odds of a 100 bp move. With recent weakness in the data, there is simply no need to go bigger this week. Updated macro forecasts and Dot Plots won’t come until the September meeting. Another 75 bp hike September 21 is about 50% priced in. A 25 bp hike is fully priced in for November 2 but after that, one last 25 bp hike is only partially priced in. The swaps market paints a similar picture, with 175 of tightening priced in over the next 6 months that would see the policy rate peak near 3.5%. After that, an easing cycle is priced in for the subsequent 6 months.

June Chicago Fed National Activity Index is concerning. It came in at -0.19 vs. 0.0 expected and vs. a revised -0.19 (was 0.01) in May. As a result, the 3-month moving average fell to -0.04 vs. a revised 0.09 in May. This was the lowest since February 2021 but still well above the -0.7 threshold that signals imminent recession. Obviously, the economy is slowing and that is what the Fed wants. However, many fear a hard landing and so we need to keep an eye on this data series as well as the U.S. yield curve. At 30 bp today, the 3-month to 10-year curve is the flattest since March 2020 and moving closer to inverting.

Regional Fed manufacturing surveys for July continue rolling out. Richmond reports today and is expected at -14 vs. -11 in June. Yesterday, Dallas Fed came in at -22.6 vs. -17.7 in June. Before that, Philly Fed came in at -12.3 vs. -3.3 in June and the Empire survey came in at 11.1 vs. -1.2 in June. Last week, preliminary July S&P Global PMI readings for the U.S. came in much weaker than expected as the composite fell to 47.5, the lowest since May 2020 and drive mostly by a drop in services to 47.0. As such, there are clearly downside risks to this week’s survey data.

Other minor U.S. data will be reported today. The focus will be on housing as May FHFA and S&P CoreLogic house price indexes will both be reported. July Conference Board consumer confidence (97.0 expected) and June new homes sales (-5.4% m/m expected) will also be reported. Again, we have to stress that a weaker housing sector is to be expected as the Fed hikes rates. Here, the worst may be over lower 10-year yields have seen 30-year fixed mortgage rates stabilize below the 6% peak last month.

Brazil reports mid-July IPCA inflation. Headline is expected at 11.41% y/y vs. 12.04% in mid-June. if so, it would be the lowest since March but still well above the 2-5% target range. Next COPOM meeting is August 3 and a 50 bp hike to 13.75% is expected. The swaps market is pricing in 100 bp of tightening over the next 6 months that would see the policy rate peak near 14.25%, followed by the start of an easing cycle over the subsequent 6 months.

EUROPE/MIDDLE EAST/AFRICA

Russia announced plans to cut gas flow through the Nord Stream pipeline. This comes less than a week after flows were restored after maintenance, albeit at only 40% of capacity. Now, it will cut output to about 20% of capacity starting Wednesday as one more gas turbine is taken out of service for maintenance. Russian spokesperson Peskov said “The situation is critically aggravated by the restrictions and sanctions imposed against our country.” He added that in the absence of sanctions, all maintenance would be carried out normally, “which would prevent situations like the one we see now.” Natural gas prices have been rising steadily and approaching the June highs.

The eurozone was already weakening and now the threat of gas shortages has risen dramatically. Germany is tipping into recession; after Germany, Italy is the most dependent on Russian energy and so it too remains at risk. We’ll know more when Q2 GDP data are reported this Friday. How aggressively can the ECB tighten given the deteriorating growth outlook? WIRP suggests 50 bp hikes are no longer fully priced in for the next meetings September 8 and October 27, while a 25 bp hike December 15 is fully priced in. Looking ahead, the swaps market is now pricing in 175 bp of tightening over the next 12 months that would see the deposit rate peak near 1.75%, down from 2.5% in mid-June.

U.K. CBI released the results of its July distributive trades survey. Retailing reported sales came in -4 vs. -10 expected and -5 in June, while total reported sales came in at -12 vs. 1 in June. Yesterday , its July industrial trends survey came in weaker than expected. Total orders came in at 8 vs. 13 expected and 18 in June, selling prices came in at 48 vs. 55 expected and 58 in June, and business optimism came in at -21 vs.-34 in June. Bank of England expectations remain subdued. WIRP suggests a 50 bp hike move at the August 4 meeting is only around 85% priced in; at the start of last week, it was fully priced in. Similarly, 50 bp hikes are no longer fully priced in for the subsequent meetings September 15 and November 3, while a 25 bp hike December 15 remains fully priced in. Looking ahead, the swaps market is still pricing in 150-175 bp of tightening over the next 6 months that would see the policy rate peak between 2.75-3.0%.

National Bank of Hungary is expected to hike the base rate 100 bp to 10.75%. However, the market is split as several analysts polled by Bloomberg look for 50, 75, and 125 bp hikes. The bank is also expected to hike the 1-week deposit rate at its weekly tender Thursday. At the June 28 meeting, the bank hiked rates 185 bp to 7.75% and two days later hiked the 1-week deposit rate 50 bp to match it. A week later, the bank hiked its 1-week deposit rate by 200 bp to 9.75% at its weekly tender and then the next week hiked the base rate 200 bp to match it. The swaps market is pricing in 125 bp of tightening over the next 6 months that would see the base rate peak near 11.0%, followed by the start of an easing cycle over the subsequent 6 months.

ASIA

Japan’s Cabinet Office raised its monthly economic assessment in for the first time in three months. It said the economy is picking up moderately, boosting its view of consumer spending, imports, and the labor market. However, risks lie ahead as a surge in COVID cases to record highs may eventually force policymakers into renewed movement restrictions. For now, it’s clear that the Bank of Japan has no intention of pivoting away from its ultra-dovish stance. The swaps market is pricing in no change in the policy rate over the next 12 months. However, the odds rise very modestly over the subsequent 24 months. We remain confident that there will be no changes through the end of Governor Kuroda’s term next spring. The choice for his replacement will be key in determining when liftoff might be seen.

The Reserve Bank of New Zealand is reviewing its monetary policy response to the pandemic. This appears to in response to a paper published today that was co-authored by former RBNZ governor Graeme Wheeler, which argues central banks are to blame for soaring inflation because they over-stimulated with aggressive rate cuts and quantitative easing. According to Governor Orr, the review will assess the RBNZ’s “recent performance in conducting monetary policy, including the use of additional monetary policy tools.” He added that the review will look at recent inflation and employment outcomes relative to the bank’s targets, review the bank’s policy decisions relative to other central banks, and estimate alternative economic outcomes if those policy decisions had not been made. Orr added that “As Governor of the Reserve Bank and Chair of the Monetary Policy Committee, I acknowledge that consumer price inflation is at 7.3%, above the Remit target range of 1-3%. I also acknowledge that the Monetary Policy Committee’s decisions over recent years have influenced this outcome.”

Korea reported firm Q2 GDP data. Growth came in at 0.7% q/q vs. 0.4% expected and 0.6% in Q1, with the y/y rate coming in at 2.9% y/y vs. 2.6% expected and 3.0% in Q1. Consumption and government spending led the charge but were offset by weak facilities investment and net exports. Domestic activity has held up relatively well even as the Bank of Korea continues its tightening cycle, while export growth has slowed sharply. The bank last hiked rates 50 bp to 2.25% on July 14. Next policy meeting is August 25 and another 50 bp hike seems likely. The swaps market is pricing in 75 bp of tightening over the next 12 months that would see the policy rate peak near 3.0%, down from 3.25% at the start of this week.

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