Dollar Firm as U.S. Returns from Holiday

September 03, 2024

Win Thin

This is a big week for the markets; Fed easing expectations remain unchanged; ISM manufacturing PMI will be the highlight; Canada highlight will be August S&P Global manufacturing PMI; Chile is expected to cut rates 25 bp to 5.5%.
ECB Governing Council member Nagel and BOE MPC member Breeden speak; U.K. BRC reported August sales; Switzerland reported August CPI and Q2 GDP data; Turkey reported August CPI
BOJ Governor Ueda sounded hawkish; Australia growth is softening; Australia reported Q2 current account data; plunging iron ore and coal prices are a big driver for AUD; New Zealand’s terms of trade improved in Q2

The dollar remains firm as the U.S. returns from holiday. DXY is trading higher near 101.852 and is the highest since August 20. The yen is outperforming after hawkish Ueda comments (see below), with USD/JPY trading lower near 146. The euro is trading lower near $1.1035 while sterling is trading lower near $1.3120. We still see scope for EUR/GBP to continue falling. With the U.S. labor market looking solid, we continue to believe that market expectations for aggressive Fed easing remain overdone (see below). We also continue to believe that the divergence story remains in place and should eventually support the dollar. This week’s data will be key in advancing our narrative, culminating with the Friday jobs report. While we believe that the dollar remains vulnerable until the dovish Fed outlook changes, its recent resilience is encouraging.

AMERICAS

This is a big week for the markets. We expect the data to confirm that the U.S. economy remains robust, driven by strong consumption and a solid labor market. With disinflation continuing, we are in a Goldilocks moment and so we continue to believe the Fed will start cutting rates this month in a very gradual manner. The drop in U.S. yields ran out of steam ahead of this week’s key data and has helped the dollar gain some traction. These trends are carrying over into this week but it will be up to the data to sustain them.

Fed easing expectations remain unchanged. The market still sees 100 bp of easing by year-end and 200 bp of easing over the next 12 months. The odds of a 50 bp cut in September are stuck around 25-30%. There are very few Fed speakers this week. Only Williams and Waller speaks Friday. At midnight Friday, the media blackout goes into effect and there will be no Fed speakers until Powell’s post-decision press conference the afternoon of September 18.

ISM manufacturing PMI will be the data highlight. Headline is expected at 47.5 vs. 46.8 in July. Risks are balanced judging from the already released regional Fed manufacturing surveys. Keep an eye on employment (43.4 in July) and prices paid (52.0 expected vs. 52.9 in July). Of note, the S&P Global manufacturing PMI fell to an 8-month low of 48.0 vs. 49.6 in July. Services PMI will be reported Thursday. Headline is expected at 51.1 vs. 51.4 in July.

Growth remains robust in Q3. The Atlanta Fed’s GDPNow model is tracking Q3 growth at 2.5% SAAR and will be updated today after the data. Elsewhere, the New York Fed’s Nowcast model is also tracking Q3 growth at 2.5% SAAR and will be updated Friday. It should also publish its first estimate for Q4 at the same time. While both model estimates are down from their earlier highs, growth remaining above trend is quite impressive in light of the Fed’s tightening.

Canada highlight will be August S&P Global manufacturing PMI. Its services and composite PMIs will be reported Thursday and all three have been below 50 for the past two months. Ivey PMI will be reported Friday.

Chile central bank is expected to cut rates 25 bp to 5.5%. However, a few of the 21 analysts polled by Bloomberg see steady rates. At the last meeting July 31, the bank delivered a hawkish surprise and kept rates steady vs. an expected 25 bp cut to 5.5%. The decision was unanimous, which was surprising since the vote to cut rates 25 bp back in July was 4-1, with the dissent in favor of a larger 50 bp move then. The bank stressed that the policy rate will continue to fall but added that the bulk of the easing was already seen in H1 of this year. August CPI will be reported Friday. Headline is expected at 4.7% y/y vs. 4.6% in July. If so, it would be the fifth straight month of acceleration to the highest since November and so we see risks of another hawkish surprise today. The market is pricing in 125 bp of easing over the next 12 months that would see the policy rate bottom near 4.5%.

EUROPE/MIDDLE EAST/AFRICA

ECB Governing Council member Nagel speaks today. Nagel cautioned last week “We need to be careful and must not lower policy rates too quickly.” Yet ECB easing expectations remain intact. A 25 bp cut this month is fully priced. While another cut in Q4 is also fully priced in, the odds of a third cut have fallen to around 40%. Despite the ECB’s cautiousness, we believe the worsening growth outlook will eventually lead to more easing than what’s currently priced in.

U.K. BRC reported August sales. Same store sales increased 0.8% y/y in August vs. 0.3% y/y in July and was boosted entirely by food sales. Overall, the recovery in real incomes and rising consumer confidence are expected to support consumption growth. Bottom line: the more encouraging U.K. growth outlook relative to the eurozone favors a lower EUR/GBP.

Bank of England MPC member Breeden speaks. For reference, Breeden voted with the majority of MPC members to cut the BOE policy rate 25 bp in August. The 5-4 margin suggests the September 19 decision will also be a close call, with the market pricing in only 25% odds of a cut in favor of November 7.

Switzerland reported August CPI data. Headline came in a tick lower than expected at 1.1% y/y vs. 1.3% in July, while core came in steady as expected at 1.1% y/y. Headline was the lowest since March and is undershooting the Swiss National Bank’s (SNB) Q3 projection of 1.5%. Bottom line: the SNB has scope to ease further. The swaps market has more than fully priced in a 25 bp cut at the September 26 meeting and implies over 25% odds of a larger 50 bp cut. We would fade the risk of a jumbo SNB cut in September, as Swiss economic activity is encouraging.

Indeed, Switzerland Q2 GDP data were firm. Growth came in at 0.7% q/q vs. 0.5% expected and actual in Q1, while the y/y rate came in at 1.8% vs. 1.5% expected and 0.6% in Q1. For reference, the SNB anticipates GDP growth of around 1% this year.

Turkey reported August CPI. Headline came in at 51.97% y/y vs. 51.86% expected and 61.78% in July, while core came in at 51.56% y/y vs. 50.10% expected and 60.23% in July. Headline decelerated for the third straight month to the lowest since July 2023. Of note, high base effects from last summer were the main driver for the steep fall in the y/y rate the past two months. Those base effects ebb over the rest of the year and so the y/y rate is likely to remain stuck well above the central bank’s year-end forecast of 38%. Next central bank meeting is September 19 and another hold seems likely. However, the market is still pricing in the start of an easing cycle over the next three months.

ASIA

Bank of Japan Governor Kazuo Ueda sounded hawkish. In a written document submitted to a government panel, Ueda stuck to the hawkish guidance that the BOJ will raise interest rates further if the economy and prices move in line with its projections. Ueda also stressed that policy remains accommodative even after the July hike, with real interest rates remaining significantly negative. He added that current monetary policy is solidly supporting economic activity. Overall, we expect the BOJ to remain cautious about tightening. The market does not price in the next hike until well into 2025, with only 25 bp of tightening seen over the next 12 months. Board member Takata speaks Thursday.

Australia growth is softening. The already released GDP input data point to unimpressive underlying growth in Q2. This should reinforce money market pricing for the RBA to start easing later this year and further undermine AUD. Tomorrow, real GDP is expected to rise 0.2% q/q vs. 0.1% in Q1, largely driven by higher government spending. Total public demand is expected to contribute 0.4pts to the quarterly change in GDP. Net exports and inventory restocking are also projected to contribute positively, albeit modestly, to Q2 growth. In contrast, private domestic demand will likely be a drag to growth judging from the contraction in retail sales volume and private capital expenditure. The market is pricing in around 75% odds of a rate cut in December.

Australia reported Q2 current account data. The deficit came in at -AUD10.7 bln vs. -AUD5.0 bln expected and a revised -AUD6.3 bln (was -AUD4.9 bln) in Q1. This is the largest quarterly current account deficit since Q2 2018, reflecting continued falls in bulk commodity prices and higher income paid to non-residents. That said, Australia’s current account deficit is small at -0.7% of GDP and should not be a huge drag on AUD.

Plunging iron ore and coal prices are a big driver for AUD. Both are trading at new lows for this cycle and are well below the levels that were seen just before China reopened in December 2022.

New Zealand’s terms of trade improved in Q2. The TOT index increased 2.0% q/q vs. 2.7% expected and 5.1% in Q1 to the highest level since Q3 2023. Resilient whole milk powder prices suggest the terms of trade will remain a modest tailwind to growth. However, the swaps market continues to price in roughly 75 bp of additional rate cuts by year-end, which is a headwind for NZD.

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