• As we expected, Fed officials are pushing back hard against the pivot theme; what we are seeing is a coordinated and well-crafted communication effort by the Fed; U.S. yields surged as a result; ISM July services PMI reading is the main event; Brazil is expected to hike rates 50 bp to 13.75%.
  
• Data suggest the ECB has already activated its first line of defense against fragmentation; final eurozone and U.K. services and composite PMIs were reported; Turkey reported July CPI
  
• Japan reported weak final July services and composite PMIs; New Zealand reported mixed Q2 jobs data; Caixin reported final China July services and composite PMIs
  

The dollar outlook has improved as the Fed pushes back against the perceived pivot. DXY traded as high as 106.549 today but has since fallen back to trade near 106.20. Clean break above 106.518 would set up a test of the July 27 high near 107.246. The euro is on track to test the July 27 low near $1.0095, weighed down by the weak eurozone outlook and lower ECB tightening expectations. Sterling remains heavy and is on track to test the July 29 low near $1.2065. USD/JPY traded near 134 today after trading as low as 130.40 yesterday and is currently trading near 133.35. We maintain our strong dollar call as Fed officials are making it clear that markets misread the Fed’s commitment to lowering inflation. However, the greenback is unlikely to get much more traction in the absence of strong economic data. This week’s U.S. data will be key for the medium-term dollar outlook.

AMERICAS

As we expected, Fed officials are pushing back hard against the pivot theme. Daly was first up yesterday and she did not disappoint. She said the Fed’s work on inflation is off to a good start but “nowhere near almost done,” adding that the Fed needs to “make good” on its commitment to hike rates. Daly added that getting supply and demand back into balance means a cooler labor market and that we may see a modest increase in the unemployment rate. Lastly, she said “I am on the soft landing side.” She was pretty much echoing Powell's tone, with all the focus on fighting inflation whilst acknowledging the economic slowdown. Lastly, Daly said it would be premature to unwind the Fed’s work and say its job is done. This last statement is a clear rebuke of the pivot theme and market pricing for an easing cycle in H1 2023.

Evans later laid out his expected rate path and it was hawkish. Regarding September, Evans said “I think that there’s enough time to play out that 50 is a reasonable assessment, but 75 could also be okay. I doubt that more would be called for.” Evans added that “I kind of expected in June that we would do 75 in June, and 75 in July, and then I thought that we would be able to step down to 50 in September, and then do 25s the rest of the year, and that’s how I got to 3.25 to 3.5. I would say that in spite of less-favorable inflation reports than I expected in June, I’m still hopeful that that rate path is a reasonable one.” Evans added that 25 bp hikes in Q1 and Q2 of net year would take the Fed Funds rate to “a sufficiently high level” of 3.75% to 4%. He said the labor market should remain strong even if growth slows, adding that “If we don’t see improvement before too long, we might have to rethink the path a little bit higher.”

Mester said the Fed has more work to do to get demand and supply balanced. She said she hasn’t seen anything that suggests inflation is leveling off and wants to see more compelling evidence that m/m inflation readings are slowing. Mester emphasized that “we have to get inflation under control.” Mester stressed that below-trend growth is not a bad outcome and is in fact necessary for price stability, adding that the Fed has a narrow path to engineer interest rates without hurting jobs. All of these comments echo Powell and should be taken as reaffirmation of the Fed’s commitment to lower inflation, not pivoting to boost growth.

Lastly, Bullard reiterated his hawkish rate path. Bluntly put, he said “I’d like to see the policy rate get to 3.75-4% this year” and that “You’ve got to go into restrictive, more restrictive territory.” Bullard stressed that a soft landing doesn’t require gradualism, adding that “Since modern central banks have more credibility than their counterparts in the 1970s, it appears that both the Fed and the ECB may be able to disinflate in an orderly manner and achieve a relatively soft landing.” He said a recession is not going to happen and forecasts H2 GDP growth to be stronger than H1.

What we are seeing is a coordinated and well-crafted communication effort by the Fed. It should leave no doubt as to the Fed's intent to keep hiking rates until inflation comes down, no matter the cost to growth and employment. The full court press by the Fed is likely to continue today. Bullard, Harker, Daly, Barkin, and Kashkari all speak and likely to maintain the hawkish tone established yesterday.

U.S. yields surged as a result. The 2-year yield has rose 20 bp to 3.07% yesterday and is trading near 3.09% today, while the 10-year yield rose 17 bp to 2.74% yesterday and is trading near 2.78% today. Of note, the 2-year differentials with Germany, the U.K., and Japan have all jumped and that’s dollar positive. While yields are sharply higher, the needle hasn't moved much in terms of Fed expectations, as the swaps market still sees a terminal Fed Funds rate of 3.5% Eventually, we think this will adjust higher to something closer to Evans' 3.75-4.0% call. Stay tuned.

ISM July services PMI reading is the main event. Headline is expected at 53.5 vs. 55.3 in June. Keep an eye on employment, which stood at 47.4 in June, and price paid, which stood at 80.1 in June. This employment component will be the final clue for Friday’s jobs data, as ADP is in the process of tweaking its models and is giving no estimate for July. Of note, manufacturing employment rose to 49.9 vs. 47.3 in June. June factory orders will also be reported and are expected at 1.2% m/m vs. 1.6% in May.

Brazil COPOM is expected to hike rates 50 bp to 13.75%. IPCA inflation came in at 11.39% y/y in mid-July, the lowest since March but still well above the 2-5% target range. If inflation continues to fall, we believe Brazil is nearing the end of the cycle. We agree with swap market pricing that suggests 75 bp of tightening over the next 3 months that would see the policy rate peak near 14.0%.

EUROPE/MIDDLE EAST/AFRICA

Data suggest the ECB has already activated its first line of defense against fragmentation. Recall that the ECB said it would first use reinvestment flows to help limit fragmentation and recent data seem to bear this out. ECB statistics on its bond holdings show that net holdings of German, French, and Dutch bonds dropped by EUR18.9 bln through July while net purchases of Italian, Spanish, Portuguese, and Greek bonds totaled EUR17.3 bln. Without these flows, we suspect the 10-year Italian spread would be north of 250 bp by now. That said, the market has yet to mount a credible test of the ECB's will to limit spreads but will have ample opportunity ahead of the September elections in Italy.

Final eurozone services and composite PMIs were reported. Services rose to 51.2 vs. 50.6 preliminary, while the composite rose half a point from the preliminary to 49.9. Looking at the country breakdown, the German composite rose a tick to 48.1, while the French composite rose to 51.7 vs. 50.6 preliminary. Italy and Spain were reported for the first time and their composite PMIs fell sharply from June to 47.7 and 52.7, respectively. Eurozone also reported June PPI and retail sales. The former rose a tick more than expected to 35.8% y/y vs. a revised 36.2% (was 36.3% in May), while the later plunged -1.2% m/m vs. flat expected and a revised 0.4% (was 0.2%) in May. Of note, Italian retail sales came in at -1.1% m/m vs. a revised 2.0% (was 1.9%) in May.

Final U.K. services and composite PMIs were also reported. Services fell to 52.6 vs. 53.3 preliminary, while the composite fell to 52.1 vs. 52.8 preliminary. This was the lowest composite reading since February 2021 and likely to fall further in the coming months. Bank of England decision come tomorrow and it is expected to hike rates 50 bp to 1.75%. Looking ahead, the swaps market is pricing in 150-175 bp of tightening over the next 6 months that would see the policy rate peak between 2.75-3.0%.

Turkey reported July CPI. Headline came in at 79.60% y/y vs. 80.24% expected and 78.62% in June, while core came in at 61.69% y/y vs. 61.25% expected and 57.26% in June. Headline was the highest since September 1998 and further above the 3-7% target range. The fact that PPI continues to accelerate suggests upward pressure on CPI will continue. Yet at the last meeting July 21, the central bank kept rates steady at 14.0%, as expected. Next policy meeting is August 18 and the bank is likely to keep rates steady again at 14.0%. Last week, the central bank revised its year-end inflation forecast to 60.4% from 42.8%, which still way too low. Governor Kavcioglu has shown no pivot from unorthodox policy but came under greater criticism from business at a meeting last week of the Istanbul Chamber of industry. We continue to believe that the nation will eventually face a balance of payments crisis that morphs into a full-blown economic crisis.

ASIA

Japan reported weak final July services and composite PMIs. Both were revised down sharply from preliminary to 50.3 and 50.2, respectively. The drop in services was largely due to the impact of record high virus numbers, and dragged the composite PMI down to the lowest since February. With inflation largely under control and the real sector data weakening, the Bank of Japan will likely feel vindicated in its decision to maintain its ultra-loose stance for the time being. Next policy meeting is September 21-22 and no change is expected then. Indeed, we maintain our call that no change will be made through the end of Governor Kuroda’s term next spring.

New Zealand reported mixed Q2 jobs data. The unemployment rate was expected to fall a tick to 3.1% but instead rose a tick to 3.3%. This was largely driven by a flat q/q reading for employment growth. It was the first rise in the rate since Q3 2020, though it is only tick above the record low 3.2% from data going back to 1985. Average hourly earnings rose 2.3% q/q vs. 1.3% expected and 1.9% in Q1, while the y/y rate rose to 3.4%, the highest since 2008. While the rise in the unemployment is noteworthy, we suspect the RBNZ is more focused on the strong wage gains and so is likely to continue its tightening cycle. The bank next meets August 17 and a 50 bp hike to 3.0% remains fully priced in. Looking ahead, the swaps market is pricing in 125 of tightening over the next 6 months that would see the policy rate peak near 3.75%, steady from the start of this week.

Caixin reported final China July services and composite PMIs. Services came in at 55.5 vs. 53.9 expected and 54.5 in June, while the composite PMI came in at 54.0 vs. 53.3 in June. This compares to the weaker official PMI readings reported over the weekend, where manufacturing came in at 49.0 vs. 50.2 in June, non-manufacturing came in at 53.8 vs. 54.7 in June, and the composite came in at 52.5 vs. 54.1 in June. With President Xi’s Covid Zero policy likely to remain in place for the foreseeable future, it seems markets will have to accept periodic ebbs and flows in the ceconomy. This is also the likely reason why policymakers have not rolled out more broad-based stimulus measures; they simply don’t want to be put in the position of adding stimulus every time there is a virus outbreak.