Dollar Flat on Muted Market Reaction to French Elections

July 08, 2024

Win Thin

The U.S. economy is still holding up relatively well; New York Fed June inflation expectations will be reported; Chile and Colombia report June CPI
The leftist parties won a surprise victory in the second round of the French elections; for now, the ECB continues to look through the French political gyrations; Germany reported weak May trade data; Israel is expected to keep rates steady at 4.5%
Japan reported mixed May cash earnings data; BOJ’s quarterly branch managers report highlighted rising wage pressures; Japan also reported May current account data; PBOC is tightening its control of short-term interest rates

The dollar is trading sideways as the new week begins. DXY is trading flat near 104.895 after fourth straight down days. The euro is trading lower near $1.0835 but has recovered since the initial post-election selling (see below), while sterling is trading flat near $1.2825. USD/JPY is trading higher near 161 after mixed wage data (see below). Recent softness in the data is challenging our view that the backdrop of persistent inflation and robust growth in the U.S. remains largely in place. However, we note that weaker data in many of the major economies underscore the fact that the relative story should continue to support the dollar.

AMERICAS

We do not think the soft June ISM and jobs data reported last will materially change the Fed's thinking near-term. The U.S. economy, whilst slowing, is still doing relatively well and so the Fed will be cautious and remain on hold at the July 30-31 FOMC meeting. The market is pricing in less than 10% odds of a cut then, rising to around 80% odds in September, unchanged from pre-NFP odds. This week’s CPI and PPI data will be key in shaping the Fed rate outlook.

The economy is still holding up relatively well. New York Fed's Nowcast model is tracking Q2 growth at 1.8% SAAR vs. 1.9% previously and Q3 growth at 2.1% SAAR vs. 2.2% previously. This is higher than the Atlanta Fed's GDPNow model, which is tracking Q2 growth at 1.5% SAAR and will be updated Wednesday after the data. Bottom line: the labor market is softening but the overall economy is still growing near trend. That should give the Fed confidence to stay on hold in July, but with an eye towards cutting rates in September.

New York Fed June inflation expectations will be reported. Expectations remain elevated, both here and in other consumer sentiment surveys. This is another reason for the Fed to stay patient.

Chile reports June CPI. Headline is expected to pick up two ticks to 4.3% y/y. If so, it would be the third straight month of acceleration to the highest since February and further above the 2-4% target range. At the last meeting June 18, the central bank cut rates 25 bp to 5.75%, as expected. The vote was 4-1, with the dissent in favor of a larger 50 bp cut. The bank signaled that the end of the easing cycle is nearing by noting “The board estimates that, if the assumptions of the central scenario materialize, the monetary policy rate would have accumulated the bulk of the cuts planned for this year during the first half.” Next meeting is July 31 and another 25 bp cut seems likely. The market is pricing in 75 bp of easing over the next twelve months that would see the policy rate bottom near 5.0%.

Colombia reports June CPI. Headline is expected at 7.15% y/y vs. 7.16% in May, while core is expected at 7.69% y/y vs. 7.83% in May. If so, headline would be the lowest since January 2022 but still well above the 2-4% target range. At the last meeting June 28, the central bank cut rates 50 bp to 11.25% by a split 4-2 vote, with the two dissents in favor of a larger 75 bp cut and one absent that did not vote. Governor Villar said rate cuts would continue but stressed that the bank needs to see a faster drop in inflation in order to cut at a faster rate. Villar added that peso weakness doesn’t merit FX intervention. The market is pricing in around 275 bp of easing over the next twelve months that would see the policy rate bottom near 8.5%.

EUROPE/MIDDLE EAST/AFRICA

The leftist parties won a surprise victory in the second and final round of the French legislative elections. The leftist New Popular Front will get 178 seats, President Emmanuel Macron’s centrist Ensemble group will get 156, and Le Pen’s far-right National Rally will get 142. All the parties fall short of an absolute majority but as the largest coalition in the 577 -seat National Assembly, NPF would have a huge influence on the legislative agenda. Reaction so far has been limited even as the worst-case outcome for the markets was avoided. However, we continue to believe that a hung parliament will generate more political instability and lead to policy gridlock, and so the euro and French bonds are likely to come under renewed downside pressure.

For now, the ECB continues to look through the French political gyrations. Over the weekend, Nagel said wage gains and services inflation remain elevated, adding “For that reason, we can’t rush with lowering interest rates.” No change is expected at the July 18 meeting, but the market is pricing in nearly 80% odds of a cut September 12.

Germany reported weak May trade data. Exports came in at -3.6% m/m vs. -2.8% expected and a revised 1.7% (was 1.6%) in April, while imports came in at -6.6% m/m vs. -1.0% expected and a revised 1.2% (was 2.0%) in April. The y/y rates worsened for the first time since February and reflects broad weakness seen recently in Germany’s industrial sector. We believe growth risks are coming to the fore in the eurozone, which helps explain the ECB’s “hawkish cut” last month.

Bank of Israel is expected to keep rates steady at 4.5%. At the last meeting May 27, the bank kept rates steady and warned that “there are several risks of a potential acceleration in inflation: geopolitical developments and their effects on economic activity, a depreciation of the shekel, continued supply constraints on activity in the construction and air travel industries, fiscal developments, and global oil prices.” The market is pricing in steady rates over the next three months, with some odds of a cut over the subsequent three months.

ASIA

Japan reported mixed May cash earnings data. Nominal cash earnings came in at 1.9% y/y vs. 2.1% expected and a downwardly revised 1.6% (was 2.1%) in April, while real earnings came in at -1.4% y/y vs. -1.2% expected and actual in April. However, the less volatile scheduled pay growth for full-time workers, which has been sticky around 2% since September 2023, came in at 2.7% y/y vs. 2.2% in April.

In related news, the BOJ’s quarterly branch managers report highlighted rising wage pressures. Indeed, many regions reported that “wage growth is broadening to surpass or is in line with last year’s elevated levels” for small- and medium-sized firms. The market is now pricing in around 60% odds of a 10 bp rate hike at the next meeting July 31, up from 50% last week, but still only a total of 35 bp of tightening over the next 12 months, unchanged from last week. Given recent softness in the economy, that’s about right in our view.

Japan also reported May current account data. The adjusted surplus came in at JPY2.406 trln vs. JPY2.051 trln expected and JPY2.524 trln in April. However, the investment flows will be of more interest. The May data showed that Japan investors were net buyers of U.S. bonds (JPY3.318 trln), the most time since January. Japan investors stayed net sellers (-JPY273.4 bln) of Australian bonds for the fifth straight month and turned net sellers of Canadian bonds (-JPY7.8mln) for the first time since February. Investors stayed buyers of Italian bonds (JPY14.3 bln) for the second straight month after three straight months of selling. Overall, Japan investors turned total net buyers of foreign bonds (JPY3.087 trln), the most since September. With Japan yields likely to move higher in H2, it’s possible that Japan investors will keep chasing higher yields abroad, but we think it’s still too early to say.

People’s Bank of China is tightening its control of short-term interest rates. It introduced a new interest rate corridor that is narrower than before by conducting repos and reverse repos on weekday afternoons. Those rates will be set 20 bp below and 50 bp above the 7-day reverse repo rate, respectively. In the past, the PBOC would only conduct money market operations on weekday mornings. We do not think this has any policy implications with regards to future easing but will simply give the PBOC greater control over money market rates and help prevent any liquidity crunches in the future.

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