• U.S. yields continue to march higher; Fed tightening expectations remain elevated as the two-day FOMC meeting begins; the only U.S. data report today is August building permits and housing starts; Canada reports August CPI
  
• U.K. Prime Minister Truss said a trade deal with the U.S. was unlikely right now; the BOE was moved to Thursday due to the Queen’s passing; the Riksbank hiked rates 100 bp to 1.75% vs. 75 bp expected
  
• Japan reported August national CPI data; the two-day BOJ meeting starts tomorrow and no changes are expected; RBA minutes were released; RBA tightening expectations remain in flux
  

The dollar remains firm as the two-day FOMC meeting begins. DXY is trading just below 110 and with the Fed expected to remain hawkish (see below), we look for a test of last week’s cycle high near 110.786. The euro remains heavy and is trading near parity. With the fundamentals deteriorating, we still look for a test of this month’s cycle low near $0.9865. Sterling also remains heavy and is likely to soon test last week’s cycle low of $1.1350, the lowest since 1985. Charts point to a test of the February 1985 all-time low near $1.0520. Lastly, USD/JPY continues to trade sideways near 143.50 as last week’s BOJ rate check continues to dampen the upward trajectory of this pair. If the BOJ meeting ends with a dovish hold Thursday as we expect, yen weakness should 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 march higher. The 2-year yield traded at a new cycle high near 3.99% today, while the 10-year yield traded at a new cycle high near 3.54%. The real 10-year yield is trading near 1.18% and is now on track to test the March 2010 high near 1.57%. 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 near 30 bp and so we are not yet ready to call for a recession in the U.S.

Fed tightening expectations remain elevated as the two-day FOMC meeting begins. WIRP suggests nearly 20% odds of a 100 bp hike. 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 starting to price in a terminal rate of 4.75% over the next 12 months, up sharply in recent days and making new highs for this cycle. Indeed, we expect a hawkish shift in the Dot Plots, with the expected policy rate moving up to 4.0% in 2022 and up to 4.25-4.5% in 2023. For 2024, the expected rate is likely to remain steady in order to underscore that any sort of pivot is not foreseen, at least for now. Powell’s press conference will be key but we expect no deviation from the hawkish tone he delivered at Jackson Hole August 26 and reinforced at his only follow-up speech September 8. There should be a singular focus on taming inflation and no hints of a pivot.

The only U.S. data report today is August building permits and housing starts. They are expected at -4.5% m/m and 0.3% m/m, respectively. Existing home sales will be reported tomorrow and are expected at -2.3% m/m vs. -5.9% in July. Of course, the housing sector is getting hit hard by rising interest rates, as the average national 30-year mortgage has risen to 6.33%, the highest since 2008 and nearing the October 2008 high near 6.41%. At some point, excess supply of housing will work its way into lower shelter costs in both the CPI and PCE baskets. However, the process is a slow one.

Canada reports August CPI. Headline is expected at 7.3% y/y vs. 7.6% in July, while core common is expected at 5.6% y/y vs. 5.5% in July. If so, headline would decelerate for the second straight month to the lowest since April vs. the 8.1% peak in June. July retail sales will be reported Friday. Headline is expected at -2.0% m/m vs. 1.1% in June, while ex-auto is expected at -1.0% m/m vs. 0.8% in June. After the weaker than expected August jobs data, markets are on alert for further signs of softness in the Canadian economy. Indeed, Bank of Canada tightening expectations have fallen. It's clear from the bank's recent that is moving away from jumbo hikes and is instead seeing how the data come in. Extremely weak jobs data for August certainly justified that decision to become more data-dependent. WIRP suggests a 50 bp hike is fully priced in for the next meeting October 26, while the swaps market is pricing in 75-100 bp of tightening over the next 6 months that would see the policy rate peak between 4.0-4.25%, down from 4.5% earlier this month. New macro forecasts will be released at next month’s meeting and will be crucial for forward guidance.

EUROPE/MIDDLE EAST/AFRICA

U.K. Prime Minister Truss said a trade deal with the U.S. was unlikely right now. Specifically, she said “There aren’t currently any negotiations taking place with the U.S. and I don’t have an expectation that those are going to start in the short to medium term.” Instead, Truss said the U.K. is focused on securing entry to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, the Gulf Cooperation Council alliance, and reaching a trade deal with India. It’s interesting that she left out any mention of Brexit and the EU, something that was one of her major platform planks. Truss arrives in the U.S. this week to attend the annual meeting of the United Nations General Assembly. It will be her first foreign trip as Prime Minister and she will meet President Biden tomorrow to focus on “Russian aggression and ensuring that Ukraine prevails and that Putin doesn’t have success in Ukraine.” However, we know that Biden is a big a backer of the Northern Ireland Protocols and so we suspect Brexit will be discussed as well.

The Bank of England decision was moved to Thursday due to the Queen’s passing. WIRP suggests a 75 bp hike is nearly 65% priced in, down from nearly 85% at the start of last week. Looking ahead, the swaps market is pricing in 300 bp of tightening over the next 12 months that would see the policy rate peak between 4.75%, up from 4.5% at the start of last week. Last week’s BOE testimony before Parliament was decidedly tepid and so markets will be looking for a much stronger statement of intent this week from Governor Bailey and his colleagues on the MPC. Updated forecasts were just released at the August 4 meeting and so the next update comes November 3.

The Riksbank hiked rates 100 bp to 1.75% vs. 75 bp expected. The bank noted that “The risk is still large that inflation becomes entrenched, and it is extremely important that monetary policy acts to ensure that inflation falls back and stabilizes. Monetary policy now needs to act more than was anticipated in June.” However, the rest of its messaging was decidedly dovish. The Riksbank sees the policy rate at 2.5% one year from now; at its last meeting June 30, the bank expected the policy rate to be 2.0% one year ahead. Both seem woefully inadequate as August headline CPI and CPIF came in at 9.8% y/y and 9.0% y/y, respectively. Of note, CPIF was the highest since July 1991 and further above the 2% target. We expect a more hawkish shift at the November 24 meeting that would move the Riksbank closer to the market. The swaps market is pricing in 175-200 bp of tightening over the next 12 months that would see the policy rate peak between 3.5-3.75%.

ASIA

Japan reported August national CPI data. Headline came in at 3.0% y/y vs. 2.6% in July, while core (ex-fresh food) came in at 2.8% y/y vs. 2.4% in July. Both were a tick higher than expected and core is the highest since September 2014 and further above the 2% target. Governor Kuroda may have to acknowledge upside risks to the FY22 core inflation forecast whilst stressing that it is likely to return back below the 2% target in FY23. Of note, core ex-energy also came in a tick higher than expected at 1.6% y/y vs. 1.2% in July.

The two-day Bank of Japan meeting starts tomorrow and no changes are expected. At the last meeting July 20-21, the bank delivered a dovish hold. Governor Kuroda emphasized that “We have no intention at all of raising rates under the yield curve control framework. We also have zero intention of expanding the 0.25% range on either side of the yield target. Right now, we need to continue to tenaciously pursue monetary easing.” A policymaker can’t get any more explicit than that and we maintain our view that current policy settings will be maintained through the end of his term next spring. Kuroda also touched on the exchange rate, noting that “If you were serious about stopping the weaker yen just with rate increases, you would need significant hikes and they would be very damaging to the economy.” Of note, the macro forecasts were updated modestly in July but did not signal a shift anytime soon from its current ultra-dovish stance. Next forecast update will come at the October 28 meeting.

Reserve Bank of Australia minutes were released. At the September 6 meeting, the bank hiked rates 50 bp to 2.35%, as expected. Minutes showed “The board expects to increase interest rates further over the months ahead, but it is not on a pre-set path given the uncertainties surrounding the outlook for inflation and growth,” The bank also spent time debating whether to hike 25 or 50 bp but concluded that “Given the importance of returning inflation to target, the potential damage to the economy from persistent high inflation and the still relatively low level of the cash rate, the board decided to increase the cash rate by a further 50 bp.” The bank “acknowledged that monetary policy operates with a lag and that interest rates had been increased quite quickly and were getting closer to normal settings.” It stressed that “All else equal, members saw the case for a slower pace of increase in interest rates as becoming stronger as the level of the cash rate rises.” Regarding unconventional policy, the bank noted that “In light of the experience, members judged it appropriate to consider use of a Bond Purchase Program (BPP) again only in extreme circumstances, when the usual monetary policy tool – the cash rate target – has been employed to the full extent possible. Compared with a yield target, a BPP provides more flexibility to respond to evolving economic circumstances, although it could entail larger financial costs.”

RBA tightening expectations remain in flux. WIRP suggests nearly 55% odds of a 50 bp move at the next meeting October 4, while the swaps market is pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 4.10%, up from 3.85% at the start of this week but down from 4.35% earlier this month. Since updated macro forecasts were released at the August 2 meeting, we won’t see the next update until the November 1 meeting.