Dollar Firm as Markets Reassess Powell’s Message

July 28, 2022
  • The two-day FOMC ended with a 75 bp hike to 2.50%; market expectations for Fed tightening are diverging; Powell was suitably hawkish during his press conference; and reiterated the Fed’s laser focus on inflation; regional Fed manufacturing surveys for July will wrap up; we get our first look at Q2 GDP; it looks like some fiscal stimulus is coming in the U.S. after all; Chile central bank releases its minutes
  • Eurozone confidence continues to plunge in July; ECB officials are starting to acknowledge recession risks; July eurozone CPI readings will start to roll out
  • BOJ Deputy Governor Amamiya sees wage gains picking up next year; Australia reported soft June retail sales

The dollar is firmer in the wake of the FOMC decision. DXY is trading back near 107 after trading as low as 106.059 earlier today. The euro is leading this move lower, driven by weak eurozone data and ECB comments that call into question its ability to tighten (see below). USD/JPY is trading at the lowest since July 6 near 135, helped by some hawkish BOJ comments (see below). We see this pair eventually recovering as BOJ liftoff is still far, far away. Sterling tested $1.22 earlier today but is following the euro lower and trading back near $1.21. We maintain our strong dollar call and believe that markets are misreading the Fed’s commitment to lowering inflation (see below). There was simply no pivot and no weakening in its resolve to lower inflation. Period.


The two-day FOMC ended with a 75 bp hike to 2.50%. The decision was unanimous and the Fed said that ongoing rate hikes likely will be appropriate. The bank stressed that it is “highly attentive” to inflation risks, which remain elevated. It noted that spending and production are softer while job gains remain robust. Lastly, the statement noted that balance sheet reduction is proceeding at its announced pace. All of this was pretty much as expected. There was no hint of a pause or that the Fed is even thinking about thinking about a pause. Updated macro forecasts and Dot Plots won’t be seen until the September meeting. The initial market response was that the Fed had pivoted. We wholeheartedly disagree.

Market expectations for Fed tightening are diverging. WIRP suggests a 50 bp hike September 21 is fully priced in, with around 30% odds of a 75 bp move. Another 25 bp hike November 2 fully priced in, with some odds of a 50 bp seen. After that, one last 25 bp hike is only about 50% priced in that would see a terminal rate near 3.5%. The swaps market paints a different picture, however, with 150-175 of tightening priced in over the next 6 months that would see the policy rate peak between 4.0-4.25%, up from 3.5% at the start of the week. An immediate easing cycle is no longer priced in.

Powell was suitably hawkish during his press conference. He said inflation is much too high and stressed that the Fed is strongly committed to bringing inflation back down to its 2% target was “essential.” He said the Fed will seek “compelling evidence” that inflation is moving down. Powell noted that the labor market remains extremely tight. Powell said improvement in labor market conditions were widespread and that labor demand remains strong even as labor supply was “subdued.” He sees some evidence of slowing in economic activity but added that it’s likely that the economy hasn’t felt the full effect of rate hikes yet.

Looking ahead, Powell said the pace of rate hikes will depend on incoming data. He thinks that it’s time to go to a meeting by meeting basis and that the Fed is likely to offer less clear guidance on rates. That said, Powell noted that another unusually large hike would really depend on the data, adding unnecessarily that it will likely be appropriate to slow the pace of hikes at some point. While this is simply stating the obvious, the markets seized on this as evidence that he was pivoting more dovish. We couldn’t disagree more. Indeed, while Powell later acknowledged that the Fed Funds rate is in the range of what the Fed considers neutral, he said that there is significant additional tightening in the pipeline and that the Fed would likely have to move to a modestly restrictive stance. While he would not specify how much more tightening he sees, Powell said the June Dots remain valid, which see 3.375% in 2022 and 3.75% in 2023 and then 3.375% in 2024.

Lastly, Powell reiterated the Fed’s laser focus on inflation. He said the Fed sees a path to lowering inflation and sustaining a strong jobs market. However, he stressed that this path has narrowed and may narrow further and admitted that “we are trying not to make a mistake.” While Fed critics would argue that the Fed has already made a mistake by waiting too long to hike, Powell noted that starting the cycle three months earlier really wouldn’t have made much difference. We concur.

The U.S. rates market continues to price in doom and gloom after the FOMC decision. The 10-year yield traded as low as 2.72% yesterday but rebounded to trade near 2.78% currently, while the 2-year yield traded as low as 2.96% yesterday and continues to trade near 2.97% currently. As a result, the 2- to 10-year curve became slightly less inverted at -20 bp after trading as low as -26 bp yesterday. The more important 3-month to 10-year also rebounded to 41 bp after trading as low as 30 bp yesterday, the flattest since March 2020. We are by no means out of the danger zone yet in terms of yield curve inversion.

Regional Fed manufacturing surveys for July will wrap up. Kansas City Fed is expected at 4 vs. 12 in June. So far, Richmond Fed came in at 0 vs. -14 expected and a revised -9 (was -11) in June, Dallas Fed came in at -22.6 vs. -17.7 in June, 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. ISM PMI readings are given more weight by the markets and will be reported next week. Obviously, there are clear downside risks to those readings.

We get our first look at Q2 GDP. Consensus sees growth at 0.5% SAAR vs. -1.6% in Q1 but we see some upside risks after yesterday’s batch of stronger than expected readings for June trade, inventories, and durable goods orders. Note that the Atlanta Fed’s GDPNow model is at -1.2% SAAR in its final Q2 update and it will unveil its the initial Q3 estimate tomorrow. Of note, Bloomberg consensus for Q3 is currently 1.7% SAAR. Weekly jobless claims will also be reported.

It looks like some fiscal stimulus is coming in the U.S. after all. After weeks and weeks of fruitless negotiations, Senator Manchin and his Democratic colleagues hammered out the framework for a $433 bln spending package that focuses on energy and climate issues. Details have yet to be finalized but the package will reportedly be financed largely by a 15% minimum tax on U.S. corporations that is meant to generate $739 bln in revenue, thereby leaving $300 bln to put toward deficit reduction. While falling far short of Biden’s last $2 trln plan, it is nonetheless good news at the margin for those of us expecting no fiscal stimulus at all this year.

Chile central bank releases its minutes. At the July 13 meeting, the bank delivered a hawkish surprise with a 75 bp hike to 9.75% vs. 50 bp expected and noted that “The board estimates that new increases in the monetary policy rate will be necessary to ensure the convergence of inflation to 3% in two years.” Next policy meeting is September 6 and a 50-75 bp hike sems likely. The swaps market is pricing in 100 bp of tightening over the next 6 months that would see the policy rate peak near 10.75%, followed by the start of an easing cycle over the subsequent 6 months. Chile reports June retail sales and IP tomorrow. Sales are expected at -5.5% y/y vs. -5.6% in May and IP is expected at -2.2% y/y vs. 1.8% in May. The economy is starting to slow sharply and so the bank is likely nearing the end of its tightening cycle.


Eurozone confidence continues to plunge in July. Economic confidence fell to 99.0 vs. 102.0 expected and a revised 103.5 (was 104.0) in June, led by the drop in consumer confidence to -27.0 vs. -23.8 in June. Of course, this shouldn’t come as any surprise after the dismal confidence readings coming out of Germany this week. However, it does underscore that it’s not just about Germany, as the entire eurozone is facing similar headwinds and risks just as the ECB begins its tightening cycle. Can the ECB continue tightening aggressively?

ECB officials are starting to acknowledge recession risks. Stournaras said in an interview that central banks everywhere will continue hiking rates to fight inflation but admitted at most until the end of 2023. He added that if the world and the eurozone enter a recession next year, markets shouldn’t be surprised if policy rates start declining then rather than increasing. This is a very different tone than Powell took yesterday as he downplayed recession risks over and over during Q&A. Elsewhere, Visco admitted that “What we see in the real economy, certainly it is not terribly encouraging” even as he said that the bank’s September decision will be based on “developments in prices and in the real economy, because the real economy affects prices.” Both are considered doves but the comments are noteworthy nonetheless. WIRP suggests 50 bp hikes are no longer fully priced in for the next ECB meetings September 8 and October 27. Looking ahead, the swaps market is now pricing in only 125 bp of tightening over the next 12 months that would see the deposit rate peak near 1.25%, down sharply from 1.75% at the start of this week.

July eurozone CPI readings will start to roll out. Germany reports later today and EU Harmonized CPI is expected to fall a tick to 8.1% y/y. German state data out already suggest slight downside risks to the national number. France and Spain report early tomorrow. Their EU Harmonized CPI readings are expected at 6.7% y/y and 10.5% y/y, respectively, and both would be higher than June. Later tomorrow, the eurozone and Italian readings will be reported. Italy’s EU Harmonized CPI is expected to rise three ticks to 8.8% y/y. For the eurozone as a whole, headline is expected to pick up a tick to 8.7% y/y, while core is expected to pick up two ticks to 3.9% y/y.


Bank of Japan Deputy Governor Amamiya sees wage gains picking up next year. His comments are noteworthy as he is believed to be one of the leading candidates to replace Governor Kuroda when his term ends next spring. Amamiya said “It is worth mentioning that further increases in wages, including base pay, can be expected from the next fiscal year onward. Under these circumstances, together with a decline in the inflation rate, wage growth is projected to exceed CPI inflation.” While this could be seen as hawkish, Amamiya pledged to “steadfastly” continue with current monetary stimulus. He said that Fed policy will have no direct impact on the BOJ. He said it’s too early to discuss specifics of an exit strategy for the BOJ, adding that possible ways to do it should always be considered and that the combination of policies for exit will hinge on the state of economy and inflation at that time. Again, this might be considered hawkish but we are talking about a 2023 or 2024 story. Either way, his views are certainly worth monitoring. July Tokyo CPI will be reported tomorrow and June labor cash earnings data will be reported next Friday, and both are likely to underscore that we are nowhere near meeting conditions for BOJ liftoff.

Australia reported soft June retail sales. Sales rose 0.2% m/m vs. 0.5% expected and a revised 0.7% (was 0.9%) in May. The data come after slightly lower than expected Q2 headline CPI was reported earlier this week, coming in at 6.1% y/y vs. 6.3% expected and 5.1% in Q1. The RBA meets next week and WIRP suggests 50 bp hikes then and September 6 are no longer fully priced in, with odds around 75% vs. 100% at the start of this week. Odds for 50 bp hikes at the October 4 and November 1 meetings have also fallen. The swaps market is pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak near 3.35%, down from 3.6% at the start of this week and nearly 4.5% at the start of this month. If the economy continues to weaken, markets will have to further reassess this expected terminal rate.

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