Dollar Firm as Global Recession Fears Rise

July 01, 2022

U.S. yields remain depressed on recession fears; the U.S. yield curve is flattening but nowhere near inverting; Fed tightening expectations have eased as recession fears have picked up; ISM manufacturing PMI will be today’s data highlight; May core PCE came in lower than expected
June eurozone CPI came in hot; yet ECB tightening expectations have softened; final eurozone manufacturing PMI readings were reported.
Japan reported June Tokyo CPI; Q2 Tankan survey was mixed; the Antipodean currencies remain under pressure; Caixin reported its June manufacturing PMI

The dollar continues to build on its recent gains. DXY is back above 105 after yesterday’s correction and remains on track to test of the June high near 105.788. The euro is trading near $1.0450 and 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 again as risk-off impulses return, with USD/JPY trading near 135 after trading at a new cycle high near 137 earlier this week. With BOJ dovishness being maintained, we still believe the pair will eventually test the August 1998 high near 147.65. Sterling is making new lows for this move near $1.2050 and remains 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.


U.S. yields remain depressed on recession fears. The 10-year yield is trading near 2.96% and is below 3.0% for the first time since June 10. Clean break below 3.0% sets up a test of the May 26 low near 2.70%. Given where inflation and the Fed are right now, we find it hard to justify a 10-year yield much below 3.0% but here we are. As long as recession fears dominate, this move lower hasn't run its course yet. And it's a global phenomenon, as 10-year yields everywhere are also down significantly in recent days. Yet we continue to feel that the U.S. is best-positioned as we enter this new phase for global investors. As such, we believe the dollar uptrend remains intact.

The U.S. yield curve is flattening but 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 129 bp, it is the flattest since early September 2021 but still far from inverting. This suggests very low odds of recession over the next 12 months but make no mistake, these odds have been rising of late.

Fed tightening expectations have eased as recession fears have picked up. WIRP suggests a 75 bp hike at the next meeting July 27 is 75% priced in vs. 85% at the start of last week, while expectations for 50 bp hikes at the subsequent meetings September 21 and November 2 are moving towards 25 bp. Looking ahead, the swaps market is now pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak between 3.25-3.50%, down from3.50-3.75% at the start of this week and nearly 4.0% at the start of last week.

ISM manufacturing PMI will be today’s data highlight. Headline is expected at 54.5 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 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. Yesterday, Chicago PMI came in at 56.0 vs. 58.0 expected and 60.3 in May. May construction spending (0.4% m/m expected) and June auto sales (13.3 mln annualized expected) will be reported today.

May core PCE came in lower than expected. Core PCE came in at 4.7% y/y vs. 4.8% expected and 4.9% in May. It was the third straight month of deceleration from the 5.3% peak in February and the lowest since November. It takes some pressure off of the Fed but 4.7% is still nowhere near the 2% target and so the Fed is likely to continue hiking aggressively in H2. Personal income and spending were reported at the same time and came in at 0.5% m/m and 0.2% m/m, respectively.


June eurozone CPI came in hot. Headline rose 8.6% y/y vs. 8.5% expected and 8.1% in May, while core rose 3.7% y/y vs. 3.9% expected and 3.8% in May. Italy also reported and its EU Harmonized inflation came in at 8.5% y/y vs. 7.9% expected and 7.3% in May. This follows France yesterday, which came in as expected at 6.5% y/y vs. 5.8% in May. Earlier this week, Spain surprised to the upside while Germany surprised to the downside. The softer core reading offers a faint ray of hope that price pressures may be close to topping out, but the ECB is likely focusing on the record high headline reading.

Yet ECB tightening expectations have softened. WIRP suggests a 25 bp hike July 21 remains fully priced in with low odds of a 50 bp move. However, odds of 50 bp hikes have fallen for the subsequent three meetings on September 8, October 27, and December 15 and so the deposit rate is seen 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.

More details of the planned ECB crisis tool have emerged. Reports suggest that the ECB has divided the eurozone into three groups: donors, recipients, and neutrals based on the size and speed of the rise in their bond spreads in recent weeks. The ECB will reportedly buy debt issued by the recipients with the profits it makes on maturing debt issued by the donors. These rebalancing efforts will begin today and additional efforts will be disclosed next month, presumably at the ECB meeting July 21. Recipients include a handful of countries such as Italy, Greece, Spain, and Portugal. We know talks are still ongoing but all signs point to yet another disappointing and underwhelming plan from the ECB. Tinkering with reinvestment proceeds is missing the big picture, which requires a much more aggressive stance that markets will be wary of challenging.

Final eurozone manufacturing PMI readings were reported. Headline eurozone manufacturing improved a tick from the preliminary to 52.1 vs. 54.6 in May. Germany’s final reading was steady at 52.0 but France improved to 51.4 vs. 51.0. preliminary. Italy and Spain reported for the first time and both fell sharply from May to 50.9 and 52.6, respectively. Final eurozone services PMI readings will be reported next Tuesday.

Bank of England expectations have eased after the weak data. WIRP suggests a 50 bp hike move at the August 4 meeting is nearly 75% priced in vs. 95% at the start of last week, and no longer fully priced in for the subsequent meetings September 15 and November 3. Looking ahead, the swaps market is now 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. Cunliffe speaks Tuesday, followed by Bailey Wednesday. Otherwise, the U.K. has a fairly quiet week. Final Q1 GDP data will be reported Thursday. May consumer credit and final June manufacturing PMI will be reported Friday.


Japan reported June Tokyo CPI. Headline came in at 2.3% y/y vs. 2.5% expected and 2.4% in May, while core (ex-fresh food) came in as expected at 2.1% y/y vs. 1.9% in May. Lastly, core ex-energy came in as expected at 1.0% y/y vs. 0.9% in May. Inflation appears to be stabilizing at levels that are much, much lower than what is being seen in the rest of the world. As a result, the Bank of Japan will feel vindicated in its steady policy. Next policy meeting is July 20-21 and no change is expected then.

Q2 Tankan survey was mixed. Large manufacturing index came in at 9 vs. 13 expected and 14 in Q1, while large non-manufacturing index came in as expected at 13 vs. 9 in Q1. Large manufacturing outlook came in at 10 vs. 13 expected and 9 in Q1, while large non-manufacturing outlook came in at 13 vs. 16 expected and 7 in Q1. Lastly, all-industry capex came in at 18.6% vs. 8.3% expected and 2.2% in Q1. It appears that the manufacturing sector is getting less optimistic even as non-manufacturing is getting more optimistic. Overall, the economy continues to recover but we know that recent mixed real sector data means that the BOJ remains wary of removing accommodation too soon. For now, it’s steady as she goes.

The Antipodean currencies remain under pressure and trading at new lows for this move. NZD is leading the move and has broken below the 62% retracement objective of the 2020-2021 rally near .6230. This sets up a test of the March 2020 low near .5470. AUD has held up better and has retraced only around half of that same rally. Here, a break below .6465 is needed to set up a test of the March 2020 low near .5510. What’s noteworthy is that an early and aggressive tightening cycle by the RBNZ has done nothing to prevent NZD from underperforming. We note the obvious that growth-sensitive currencies such as the dollar bloc and EM are likely to underperform during this period of heightened global recession fears.

Caixin reported it June manufacturing PMI. It came in at 51.7 vs. 50.2 expected and 48.1 in May and follows strong official PMI readings earlier this week. 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.

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