Dollar Firms as Markets Start to Believe the Fed

June 28, 2023

Win Thin

Markets are starting to price in that second Fed hike this year; the U.S. data remain strong; Canada May CPI came in soft
Eurozone June CPI data have started rolling out; Italy may come in to focus again; Germany reported weak July GfK consumer confidence
Japan restored Korea to its list of preferred trading partners; Australia reported soft May CPI data

The dollar is getting some traction as U.S. data remain strong. DXY is trading higher near 102.574 after two straight down days. The euro is trading flat near $1.0960 while sterling is trading lower near $1.2710. USD/JPY traded at a new high for this move near 144.25 before falling back to trade near 144 currently. AUD is underperforming after lower than expected CPI data (see below). The FX market remains choppy as markets try to get a handle on Fed policy. With markets now starting to price in that second Fed hike this year (see below), the dollar may get further traction. PCE data this Friday and jobs data next Friday will be key to this repricing.

AMERICAS

Markets are starting to price in that second Fed hike this year. WIRP suggests a 25 bp hike is nearly priced in for September, with odds of a second 25 bp hike topping out near 10% for November. PCE data Friday may help solidify those odds, with headline expected at 3.8% y/y vs. 4.4% in April and core expected to remain steady at 4.7% y/y.

The U.S. data remain strong. Yesterday, May durable goods orders came in at 1.7% m/m vs. -0.9% expected and a revised 1.2% (was 1.1%) in April. Elsewhere, June Conference Board consumer confidence came in at 109.7 vs. 104.0 expected and a revised 102.5 (was 102.3) in May. Richmond Fed manufacturing index came in at -7 vs. -12 expected and -15 in May while Dallas Fed services index came in at -8.2 vs. -17.3 in May. May wholesale and retail inventories and advance goods trade data will be reported today.

Housing data continue to firm. April FHFA and S&P CoreLogic house price indices both came in higher than expected, while May new homes sales came in at 12.2% m/m vs. -1.2% expected and a revised 3.5% (was 4.1%) in April. May pending home sales will be reported tomorrow and are expected at -0.5% m/m vs. flat in April. The rebound in housing is all the more remarkable given elevated mortgage rates, with the 30-year fixed rate national average of 7.11% just below the peak near 7.20% from late May.

Canada May CPI came in soft. Headline came in as expected at 3.4% y/y vs. 4.4% in April and was the lowest since June 2021, while both median and trim measures came in a tick lower than expected at 3.9% y/y and 3.8% y/y, respectively. Common core came in at 5.2% y/y vs. 5.7% in April and was the lowest since March 2022. Bank of Canada tightening expectations fell slightly as result. WIRP suggests over 50% odds of a hike July 12 vs. nearly 70% at the start of this week but remains fully priced in September 6. Odds of another 25 bp hike in Q4 top out near 25% vs. 70% at the start of this week.

EUROPE/MIDDLE EAST/AFRICA

Eurozone June CPI data have started rolling out. Italy reported today and its EU Harmonised inflation came in at 6.7% y/y vs. 6.8% expected and 8.0% in May. Spain and Germany report tomorrow and their EU Harmonised y/y rates are expected at 6.8% and 1.5%, respectively. France reports Friday and its EU Harmonised y/y rate is expected at 5.4% vs. 6.0% in May. Eurozone also reports Friday, with headline expected at 5.6% y/y vs. 6.1% in May and core expected at 5.5% y/y vs. 5.3% in May. Though headline inflation has been falling, ECB policymakers remain very concerned about elevated core readings.

ECB tightening expectations have steadied WIRP suggests odds of a 25 bp hike are near 90% July 27. Odds of another 25 bp hike stand near 60% September 14 and top; out near 90% December 14. Reports suggest some ECB officials are pushing for a faster pace of Qt. Of note, eurozone May M3 came in at 1.4% y/y vs. 1.5% expected and 1.9% in April. This was the slowest since May 2014 and points to slower economic growth ahead.

Italy may come in to focus again. That’s because Prime Minister Meloni has joined the chorus of complaints from her Deputy Prime Ministers about tighter ECB policy. She told parliament today that “The simplistic recipe of increasing interest rates isn’t seen by many as the right path. It cannot be ignored that constantly increasing rates risks harming our economies more than it reduces inflation, making it a cure that does more harm than good.” This comes after Salvini called expected rate hikes “nonsense and dangerous” and Tajani said they risked triggering a recession. Most European politicians know that criticizing the ECB is a big no-no. Markets have been giving Italy the benefit of the doubt recently, with 10-year spreads to Germany trading earlier this month at a cycle low near 155 bp before rebounding to 166 bp currently. Perhaps markets should reprice Italian risk even more in light of these comments from Italian officials.

Germany reported weak July GfK consumer confidence. Headline came in at -25.4 vs. -23.0 expected and a revised -24.4 (was -24.2) in June. This was the first drop since October and comes after a weak June IFO business climate report Monday. Then, headline came in at 88.5 vs. 90.7 expected and a revised 91.5 (was 91.7) in May. This was the second straight drop in the headline to the lowest since December as both current assessment and expectations fell. Preliminary June PMI readings suggest Germany is moving closer to recession, as its composite PMI of 50.8 is nearing the key 50 boom/bust level.

ASIA

Japan restored Korea to its list of preferred trading partners. Trade Minister Yasutoshi Nishimura said this will take effect July 21 and comes about three months after Korea made a similar move. Back in March, Japan rolled back export restrictions on key semiconductor materials for Korea. All these moves come as the leaders of Japan, Korea and the U.S. prepare for a trilateral summit, which press reports suggest could be held as soon as late August. Elsewhere, Taiwan’s Vice Premier Cheng Wen-tsan is visiting Japan this week to improve economic ties and to discuss the semiconductor industry.

Australia reported soft May CPI data. Headline came in at 5.6% y/y vs. 6.1% expected and 6.8% in April. This was the lowest since April 2022 but still well above the 2-3% target range. RBA tightening expectations fell slightly as result. WIRP suggests less than 20% odds of a hike July 4 vs. nearly 30% at the start of this week but rise to nearly 75% August 1 and remains fully priced in September 5. Odds of another 25 bp hike in Q4 top out near 40% vs. fully priced in at the start of this week. May retail sales data tomorrow will also be important. AUD is underperforming today. It traded at the lowest level since June 6 near 0.6620 and a clean break of 0.6625 sets up a test of the May 31 low near 0.6460.

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