Dollar Flat Ahead of Retail Sales and FOMC Minutes

August 17, 2022

Win Thin

FOMC minutes will be closely watched; Fed tightening expectations have steadied; July retail sales will be the data highlight; Canada reported July CPI data yesterday
U.K. July CPI data ran hot; final eurozone Q2 GDP data were revised lower.
Japan reported July trade data and June core machine orders; RBNZ hiked rates 50 bp to 3.0% and took a more hawkish tone; despite the hawkish RBNZ decision, NZD is the second worst performing major currency today

The dollar is little changed ahead of retail sales data and FOMC minutes. DXY is flat for the second straight day and is trading near 106.53 currently. The euro remains heavy and is currently trading flat near $1.0175. A break below $1.0110 is needed to set up a test of the July 14 cycle low near $0.9950. Sterling is currently trading flat near $1.21, supported in part by higher than expected CPI readings that suggest more aggressive BOE tightening is needed (see below). USD/JPY is inching higher to trade near 135, the highest since August 10 and nearing a test of the August 8 high near 135.60. After that is the July 27 high near 137.45. Kiwi is underperforming despite the more hawkish RBNZ (see below). We maintain our strong dollar call as the dollar smile seems intact. As risk-off impulses ebb, the dollar should still benefit from the relatively strong U.S. economic outlook and heightened Fed tightening expectations.

AMERICAS

FOMC minutes will be closely watched. We expect the minutes to come in very hawkish. Recall that at the July meeting, the bank hiked rates 75 bp and set a generally hawkish tone in its statement. It wasn’t until Chair Powell’s post-decision press conference that markets saw what they believed was a dovish pivot, when he acknowledged the pace of future rate hikes will depend on incoming data. Powell noted that another unusually large hike would really depend on the data, adding unnecessarily that it will likely be appropriate to slow the pace of hikes at some point. While this is simply stating the obvious, the markets seized on this as evidence that he was pivoting more dovish. Because the Fed has embarked on a corrective communication effort since that meeting, the minutes should reveal more about the Fed’s hawkish thinking then.

Fed tightening expectations have steadied. WIRP suggests a 50 bp hike is fully priced in for the September 20-21 FOMC meeting, with 55% odds of a 75 bp hike. We believe that if the market eventually gives the Fed 75 bp next month, the Fed will take it. Looking ahead, the swaps market is now pricing in a 3.75% terminal rate vs. 3.5% at the start of last week. However, the market is still pricing in a quick turnaround by the Fed into an easing cycle in 2023. It's pretty clear that the Fed doesn't see it that way and the data bear that out, at least for now. We suspect the minutes will also show that a quick pivot is unlikely. Markets should reprice these easing expectations in the coming days and weeks.

July retail sales will be the data highlight. Headline sales are expected at 0.1% m/m vs. 1.0% in June, while sales ex-autos are expected at -0.1% m/m vs. 1.0% in June. Lastly, the so-called control group used for GDP calculations is expected at 0.6% m/m vs. 0.8% in June. The Atlanta Fed’s GDPNow model is currently tracking 1.8% SAAR growth for Q3 vs. 2.5% previously. However, it’s early on and so each data point can lead to big swings in the estimate. June business inventories will also be reported and are expected at 1.4% m/m. Next update to the model will be released today after the data dump.

Canada reported July CPI data yesterday. Headline CPI came in as expected at 7.6% y/y vs. 8.1% in June, but core common came in at 5.5% y/y vs. 4.7% expected a revised 5.3% (was 4.6%) in June. This is a similar dynamic to what we are seeing in the U.S., where lower energy prices are pushing down headline inflation even as broad-based price gains are pushing up core inflation. Bank of Canada meets September 7 and a 75 bp hike is 80% priced in, up from 40% at the start of this week. The swaps market is now pricing in 125 bp of tightening over the next 6 months that would see the policy rate peak near 3.75%, up from 3.5% at the start of this week. Similar to the Fed, the market sees the start of an easing cycle in 2023 and we also disagree with this expected pivot by the BOC.

EUROPE/MIDDLE EAST/AFRICA

U.K. July CPI data ran hot. Headline came in at 10.1% y/y vs. 9.8% expected and 9.4% in June, core came in at 6.2% y/y vs. 5.9% expected and 5.8% in June, and CPIH came in at 8.8% y/y vs. 8.6% expected and 8.2% in June. Of note, the Bank of England sees headline inflation peaking near 13% in October. Market expectations have risen sharply on the realization that the bank is set to continue tightening as inflation spirals ever higher. WIRP suggests a 50 bp hike September 15 is fully priced in, with 25% odds now seen of a larger 75 bp move. The swaps market is now pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak near 3.75% vs. 3.25-3.50% as the start of this week and 3.0-3.25% at the start of last week.

Final eurozone Q2 GDP data were revised lower. Growth was revised to 0.6% q/q vs. 0.7% advance, while the y/y rate was revised to 3.9% vs. 4.0% advance. At the same time, employment rose 0.3% q/q vs. 0.6% in Q1, while the y/y rate slowed to 2.4% vs. 2.9% in Q1. ECB tightening expectations have steadied a bit. WIRP suggests a 50 bp hike is about 90% priced in for September 8, while the swaps market is pricing in 150 bp of tightening over the next 12 months that would see the deposit rate peak near 1.5%.

ASIA

Japan reported July trade data and June core machine orders. Exports came in at 19.0% y/y vs. 17.6% expected and 19.3% in June, while imports came in at 47.2% y/y vs. 45.5% expected and 46.1% in June. As a result, the adjusted traded deficit came in at a record -JPY2.13 trln vs. -JPY1.9 trln expected. The external sector should remain a drag on growth, though it was neutral for Q2. Due to its status as a net creditor nation, Japan is still running current account surpluses but remains on a narrowing trend. The OECD forecasts the surplus to narrow to 1.5% of GDP this year and 1.2% next year vs. 2.8% in 2021. Elsewhere, orders came in at 6.5% y/y vs. 7.7% expected and 7.4% in May. High base effects from last year played a role but the slowing trend is unmistakable. All in all, the recent data support the BOJ’s decision to maintain steady policy. Next meeting is September 21-22 and no change is expected then.

Reserve Bank of New Zealand hiked rates 50 bp to 3.0% and took a more hawkish tone. Updated macro forecasts and expected rate path were released that show a more hawkish stance. The new rate path sees a year-end policy rate of 3.7% vs. 3.4% in May, followed by an end-2023 policy rate of 4.1% vs. 3.9% in May. The bank said “The committee agreed that domestic inflationary pressures had increased since May and to further bring forward the timing of OCR increases.” Just like the last meeting July 13, the bank said it was appropriate to keep raising rates “at pace.” Governor Orr said “Our view is that sitting around that 4% official cash rate level buys the monetary policy committee right now significant comfort that we would have done enough to see inflation back to our remit.” Next policy meeting is October 5 and another 50 bp hike to 3.5% is 85% priced in. The swaps market is pricing in 150 bp of tightening over the next 6 months that would see the policy rate peak near 4.5%, which is above the bank’s new expected rate path.

Despite the hawkish RBNZ decision, NZD is the second worst performing major currency today. Clean break below the .6810 area would set up a test of the August 5 low near .6215. AUD is actually leading this move, as it has already broken below the key level near ..6970 that sets up a test of its August 5 low near .6870. With China’s outlook deteriorating, we expect the Antipodeans to continue underperforming. On the other hand, Canada is dependent on the U.S. and so CAD should outperform within the dollar bloc. As it is, CAD is the best performing major YTD and that should continue.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2022. All rights reserved.