Dollar Flat Ahead of Retail Sales Data

September 15, 2022

Win Thin

The potential nationwide rail strike has been avoided; August PPI was reported yesterday; Fed tightening expectations remain elevated; August retail sales data today will be important; regional Fed manufacturing surveys for September start rolling out
ECB messaging is starting to soften; the doves have been quiet of late and so these comments are noteworthy; Israel reports August CPI
Japan reported August trade data; the yen is trading sideways after yesterday’s rate checks by the BOJ; Australia reported solid August jobs data; New Zealand reported solid Q2 GDP data

The dollar is flat ahead of retail sales data. After trading at a new low for this move near 107.68 Tuesday, DXY reversed and traded as high as 110 yesterday before falling back to trade flat near 109.657 currently. We look for a test of last week’s cycle high near 110.786. The euro remains heavy and is trading just below parity. We still look for a test of last week’s cycle low near $0.9865. Sterling also remains heavy and is trading just below $1.15. We look for a test of last week’s cycle low near $1.1405. Lastly, USD/JPY is trading sideways near 143.55 after yesterday’s BOJ rate check. 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

The potential nationwide rail strike has been avoided. An eleventh hour deal was struck last night that addresses the contentious issues of work rules, sick leave, healthcare, and pay structure in a way that balances the needs of both the workers and the railroads . If the two sides hadn’t reached an agreement, a strike could have begun as soon as tomorrow. Data show that around 30% of U.S. goods are still transported by rail. With supply chains not yet near normal, a strike couldn’t have come at a worse time. Thankfully, that has now been avoided.

August PPI was reported yesterday. Headline PPI came in at 8.7% y/y vs. 8.8% expected and 9.8% in July, while core PPI came in at 7.3% y/y vs. 7.0% expected and a revised 7.7% (was 7.6%) in July. Compared to CPI, PPI was relatively benign but the damage had already been done. It’s clear that the Fed’s task will be a long and arduous one and there will be no quick fixes.

Fed tightening expectations remain elevated. WIRP suggests 25% odds of a 100 bp hike next Wednesday. 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. Of course, such a move would likely tank equity markets but if that is what is needed to tighten monetary conditions, so be it. Looking ahead, the swaps market is pricing in a terminal rate of 4.5%, up sharply in recent days and making new highs.

August retail sales data today will be important. Headline sales are expected at -0.1% m/m vs. flat in July, while sales ex-autos are expected at flat m/m vs. 0.4% in July. The so-called control group used for GDP calculations is expected at 0.5% m/m vs. 0.8% in July. Can the U.S. consumer remain strong? Household earnings are getting squeezed but the labor market remains strong and consumer confidence is recovering. Of note, the Atlanta Fed’s GDPNow model is tracking 1.3% SAAR growth for Q3, down a tick from the previous reading. The next model update will be seen today after the data.

Regional Fed manufacturing surveys for September start rolling out. Both the Empire and Philly Fed surveys kicks things off today. The former is expected at -12.8 vs. -31.3 in August, while the latter is expected at 2.5 vs. 6.2 in August. August IP will also be reported and is expected flat m/m vs. 0.6% in July. For now, the manufacturing sector has remained resilient. Weekly jobless claims, August import/export prices, and July business inventories will also be reported.

EUROPE/MIDDLE EAST/AFRICA

The ECB messaging is starting to soften. Chief Economist Lane said “We expect that this transition will require us to continue to raise interest rates over the next several meetings. The appropriate size of an individual increment will be larger, the wider the gap to the terminal rate and the more skewed the risks to the inflation target.” In other words, future hikes will depend on the inflation trajectory and the terminal rate needed to push inflation back to the 2% target. While this may sound hawkish at first blush, we believe it moves the ECB back to a data-dependent path. Elsewhere, Villeroy said the ECB should reach the neutral rate (R*) as soon as possible, noting “In the euro area, R* can be estimated as below or close to 2% in nominal terms, and we could be there by the end of the year. Doing so is normalization, only beyond R* would tightening begin if needed.”

The doves have been quiet of late and so these comments are noteworthy. WIRP suggests 80% odds of another 75 bp hike October 27. Looking ahead, the swaps market is pricing in another 200 bp of further tightening over the next 12 months that would see the deposit rate peak near 2.75%.

Israel reports August CPI. Headline is expected at 4.8% y/y vs. 5.2% in July. If so, it would be the first deceleration since March but still well above the 1-3% target range. At the last meeting August 22, the bank delivered a hawkish surprise with a 75 bp hike to 2.0% vs. 50 bp expected. The swaps market is now pricing in a terminal rate between 3.0-3.25% vs. 2.25% right before that meeting. Next policy meeting is October 3 and a 50 bp hike seems likely along with risks of another hawkish surprise. Updated macro forecasts will be released then. The last set of forecasts from the July meeting saw the policy rate at 2.75% in Q2 2023 but that rate path has likely steepened now.

ASIA

Japan reported August trade data. Exports came in at 22.1% y/y vs. 24.1% expected and 19.0% in July while imports came in at 49.9% y/y vs. 46.9% expected and 47.2% in July. As a result, the adjusted balance came in at -JPY2.37 trln vs. -JPY2.085 trln expected and -JPY2.155 trln in July. The external accounts continue to worsen as energy costs boost imports and weak global growth dampens exports. The OECD forecasts Japan’s current account surplus to narrow to 1.5% of GDP this year and 1.2% next year from 2.9% in 2021. This narrowing surplus is another headwind for the yen.

The yen is trading sideways after yesterday’s rate checks by the Bank of Japan. Its September 21-22 meeting has taken on a bit more importance in light of the bank’s pushback against the weak yen. While we expect USD/JPY to resume its climb, markets will be reluctant to sell the yen ahead of that BOJ meeting on the off chance (very unlikely) that the bank does do some sort of pivot next week. As faithful readers know, we have long held that FX intervention without a change in the BOJ’s underlying ultra-dovish stance would have little lasting impact. We maintain our call that the BOJ will not pivot until 2023 at the earliest and so the yen should continue to weaken.

Australia reported solid August jobs data. 33.5k jobs were added vs. 35.0k expected and -40.9k in July, but the unemployment rate still rose a tick off the record low in July to 3.5% as the participation rate rose two ticks to 66.6%. The mix was favorable, with 58.8k full-time jobs added and -25.3k part-time jobs lost. WIRP suggests 35% odds of a 50 bp hike October 4 while the swaps market is pricing in 150 bp of tightening over the next 12 months that would see the policy rate peak near 3.85%, up from 3.60% at the start of this week and 3.75% at the start of last week.

New Zealand reported solid Q2 GDP data. Growth came in at 1.7% q/q vs. 1.0% expected and -0.2% in Q1, while the y/y rate came in at 0.4% vs. flat expected and a revised 1.0% (was 1.2%) in Q1. After weak Q2 manufacturing activity and real retail sales were reported, we saw downside risks to Q2 GDP and so this was a welcome surprise. WIRP suggests a 50 bp hike to 3.5% October 5 is fully priced in, while the swaps market is pricing in 125 bp of tightening over the next 6 months that would see the policy rate peak near 4.25%, down from 4.5% at the start of last week.

People’s Bank of China left its 1-year MLF rate steady at 2.75%, as expected. The bank just cut the rate 10 bp August 15 and so another cut so soon seems unlikely. The PBOC also drained liquidity by a net CNY200 bln while China’s biggest banks cut deposit rates across the board for the first time since 2015. We see further stimulus in the coming months after August inflation data surprised to the downside. August IP and retail sales will be reported tomorrow. IP is expected to remain steady at 3.8% y/y, while sales are expected at 3.2% y/y vs. 2.7% in July. We continue to see downside risks to the economic data as policymakers so far are only adding modest stimulus.

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