- Fed speakers will be closely scrutinized this week; inflation expectations have risen after the perceived Fed pivot; July ISM manufacturing PMI was solid; Colombia central bank minutes will be released
German electricity prices are setting new record highs; ECB tightening expectations remain depressed.
Regional tensions remain high as U.S. House Speaker Pelosi visits Taiwan; reports suggest Japan will propose a record hike in the minimum wage; RBA hiked rates 50 bp to 1.85%, as expected; tightening expectations are adjusting accordingly after the pivot; some updated forecasts were revealed
The dollar is getting some limited traction as risk off sentiment takes hold. DXY is up for the first time after four straight down days and trading near 105.541 as House Speaker Pelosi’s Taiwan visit has led to tensions with China (see below0. The yen continues to lead this move, with USD/JPY trading as low as 130.40 today. Charts suggest a test of the May 24 low near 126.35, though the 130 level should offer some support. The euro traded at a new high for this move near $1.0295 today but remains constrained by the weak eurozone outlook and lower ECB tightening expectations (see below). Sterling was unable to build on yesterday’s move to $1.2260 and is now trading back near $1.22. AUD is the worst performing major today after the RBA’s dovish pivot (see below). We maintain our strong dollar call and believe that markets are misreading the Fed’s commitment to lowering inflation. However, the greenback is unlikely to get much traction in the absence of strong economic data. This week’s U.S. data will be key for the medium-term dollar outlook.
Fed speakers will be closely scrutinized this week. We do not think Fed officials are very happy with the market’s dovish take on its decision last week and they are likely to push back this week. As such, prepare for comments that tilt decidedly hawkish. Evans, Mester, and Bullard speak today. Harker, Barkin, and Kashkari speak tomorrow. Mester speaks again Thursday and Barkin speaks again Friday. Over the weekend, uber-dove Kashkari reiterated that the Fed is focused on lower inflation, noting that “We are committed to bringing inflation down and we’re going to do what we need to do. We are a long way away from achieving an economy that is back at 2% inflation, and that’s where we need to get to.” We concur.
Inflation expectations have risen after the perceived Fed pivot. The 10-year inflation breakeven spiked from 2.35% up to nearly 2.50% on the FOMC decision day July 27. Presumably, this suggests that the market views the Fed as being slightly more lax on its fight against inflation. Yet the nominal 10-year yield is falling precipitously and traded as low as 2.51% earlier today. As a result, the real 10-year yield has plummeted to a mere 5 bp from 82 bp in mid-June and 72 bp in early July.
July ISM manufacturing PMI was solid. Headline came in at 52.8 vs. 52.0 expected and 53.0 in June. The details were a bit mixed but overall decent, as prices paid plunged to 60.0 vs. 73.5 expected and 78.5 in June, the lowest level since August 2020. Of note, supplier deliveries fell to 55.2 vs. 57.3 in June and backlog of orders fell to 51.3 vs. 53.2 in June, both the lowest since 2020. The lower these two numbers are, the lower the strains in the supply chains. Employment rose to 49.9 vs. 48.2 expected and 47.3 in June, while production fell to 53.5 vs. 54.9 in June. ISM services PMI will be reported tomorrow. Headline is expected at 53.7 vs. 55.3 in June.
We get some minor data today. JOLTS job openings for June will be reported and expected at 11 mln vs. 11.254 mln in May. July vehicle sales will be reported and are expected at 13.5 annualized vs. 13.0 in June. Elsewhere, Canada July S&P Global manufacturing PMI will be reported.
Colombia central bank minutes will be released. At that meeting last Friday, the bank hiked rates 150 bp to 9.0%, as expected. July CPI will be reported Friday. Headline is expected at 9.97% y/y vs. 9.67% in June. If so, headline would be the highest since May 2000 and further above the 2-4% target range. Next meeting is September 30 and another 150 bp hike to 10.5% seems likely. The swaps market is pricing in another 150-175 bp of tightening over the next 6 months that would see the policy rate peak between 10.50-10.75%. We see upside risks here.
German electricity prices are setting new record highs. Drought, record heat, and limited natural gas shipments from Russia have all conspired to push power prices for next year to a record high EUR405 per megawatt-hour. July PMI readings suggest the German economy is already contracting and so it’s only going to get worse after its GDP stagnated in Q2. And as Germany goes, so goes the eurozone.
ECB tightening expectations remain depressed. WIRP suggests a 50 bp hike is only about 70% priced in for the next meeting September 8 and even lower for the October 27 meeting. Looking ahead, the swaps market is now pricing in 100 bp of tightening over the next 12 months that would see the deposit rate peak near 1.0%. This has fallen sharply from 2.5% seen in mid-June and 2.0% seen in mid-July as weak data and the threat of gas shortages have raised eurozone recession concerns.
Regional tensions remain high as U.S. House Speaker Pelosi visits Taiwan. The move could be seen as unnecessarily inflammatory, coming so soon after last week’s testy call between Presidents Biden and Xi. We don’t want to put too much emphasis on Pelosi’s visit or on China’s saber-rattling response. Let’s just say the episode has led to some risk-off impulses that are boosting the usual haven assets today. We suspect that this safe haven bid is unlikely to be sustained for very long.
Reports suggest Japan will propose a record hike in the minimum wage. An advisory panel at the Labor Ministry has reportedly decided to seek a JPY31 hike in the national average of minimum hourly wages from the current JPY930 yen (a 3.3% gain) this fiscal year. If finalized, that would be the largest increase in both absolute and percentage terms since the government began using hourly pay as the benchmark in 2002. We know that BOJ views higher wages as the missing ingredient for sustainably higher inflation and so the increase is noteworthy if it drives other wages higher as well. June labor cash earnings and household spending data will be reported Friday. Nominal earnings are expected at 1.9% y/y vs. 1.0% in May, while real earnings are expected at -1.3% y/y vs. -1.8% in May. The issue of wages has gained more importance after Deputy Governor Amamiya said last week that he expects wage pressures to pick up next year.
Reserve Bank of Australia hiked rates 50 bp to 1.85%, as expected. Governor Lowe said “The board expects to take further steps in the process of normalizing monetary conditions over the months ahead, but it is not on a pre-set path,” adding that the “size and timing” of future moves will be “guided by the incoming data.” The bank noted that “Inflation is expected to peak later this year and then decline back towards the 2–3% range. The expected moderation in inflation reflects the ongoing resolution of global supply-side problems, the stabilization of commodity prices and the impact of rising interest rates.” This is what a dovish pivot looks like.
RBA tightening expectations are adjusting accordingly after the pivot. WIRP suggests a 25 bp hike at the next meeting September 6 is fully priced in, with only 15% odds of a larger 50 bp move. Same goes for the October 4 and November 1 meetings. Looking ahead, the swaps market is pricing in 180 bp of tightening over the next 6 months that would see the policy rate peak near 3.65%. AUD is the worst performing major today on the RBA pivot and is trading back below .70. It has retraced more than a third of its July rally; key levels to watch for are .6865 (50% retracement objective) and .6820 (62%).
Some updated forecasts were revealed. Inflation is forecast at 7.75% this year, a little above 4% next year, and around 3% in 2024. Growth is forecast at 3.25% this year and 1.75% both next year and 2024. Lastly, unemployment is forecast around 4% in 2024. The bank will release its Statement on Monetary Policy Friday that contains a full set of updated macro forecasts and adds December 2024 to the forecast horizon.