Dollar Gets Some Traction Ahead of the Weekend

August 12, 2022

Win Thin

Fed speakers continue spreading the hawkish message; PPI data also came in on the soft side; preliminary August University of Michigan consumer sentiment will be today’s data highlight
The monthly U.K. data dump began; eurozone June IP was reported; Sweden reported July CPI
Taiwan revised Q2 GDP growth slightly lower; India reports July CPI and June IP

The dollar is getting some traction ahead of the weekend. DXY is up for the first time after four straight down days and is trading near 105.50 currently. The euro rally this week ran out of steam near $1.0360, which is the 62% retracement objective of the June-July drop. After failing to break that level twice, the euro is currently trading back below $1.03. Sterling is underperforming despite better than expected data and is currently trading near $1.2125. A break below $1.2110 would set up a test of the August 5 low near $1.20. USD/JPY is creeping higher to trade near 133.65 after trading as low as 131.75 yesterday. A break above 134.10 is needed to set up a test of the August 8 high near 135.60. We maintain our strong dollar call but acknowledge that a period of consolidation is likely to be seen until markets readjust Fed tightening expectations higher. Hawkish Fed officials are doing their part (see below) but we need to continue seeing strong U.S. data.

AMERICAS

Fed speakers continue spreading the hawkish message. Daly spoke late yesterday and said that while she views a 50 bp hike next months as a baseline, she has an open mind on whether 75 bp is needed. Daly stressed that the size of the rate hike doesn’t depend on one data point but sees the Fed Funds rate at 3.4% by year-end followed by more restricting policy next year in order to curb inflation. It seems Daly remains somewhat in the center of the Fed spectrum, as her 3.4% year-end rate call lines up with Evans’ call for 3.25-3.5%. Both are a bit lower than Kashkari’s 3.9% call, who is shaping up to amongst the most hawkish along with Bullard and Waller. Today, Barkin speaks.

Fed tightening expectations continue to adjust. WIRP is now showing only 50% odds of a 75 bp hike at the September 20-21 FOMC meeting, down from over 80% before the CPI/PPI data. Looking ahead, the swaps market is now pricing in a 3.5% terminal rate vs. 3.75% at the start of this week. While September 21 is still a long ways away, we see risks of a hawkish surprise then. What better way to get markets to finally get its hawkish message than delivering an out of the consensus 75 bp? The Fed’s August 25-27 Jackson Hole Symposium is unlikely to yield any policy surprises but the Fed could use it as an opportunity to push back further against the market’s dovish take. Stay tuned.

U.S. PPI data also came in on the soft side. Headline came in at 9.8% y/y vs. 10.4% expected and 11.3% in June, while core came in at 7.6% y/y vs. 7.7% expected and a revised 8.4% (was 8.2%) in June. This suggests further downward pressure in CPI readings in the coming months. While more and more inflation measures are showing signs of topping out, it is way too early for the Fed to declare victory. The Fed’s preferred measure core PCE will be reported in two weeks on August 26. Of note, core PCE decelerated three straight months after the 5.3% y/y peak in February but then ticked up in June. In other words, inflation doesn’t always move in a straight path up or down and so we can expect some setbacks from time to time.

Preliminary August University of Michigan consumer sentiment will be today’s data highlight. Headline is expected to rise a point to 52.5, driven largely by a solid rise in expectations that offsets an expected drop in current conditions. If so, it would be the second straight increase in the headline reading off the 50.0 low in June. Both 1-year and 5-year inflation expectations are expected to fall a tick to 5.1% and 2.8%, respectively. July import/export prices will also be reported today.

EUROPE/MIDDLE EAST/AFRICA

The monthly U.K. data dump began. June GDP, June construction output, IP, index of services, and trade were all reported. Q2 GDP was also reported and came in at -0.1% q/q vs. -0.2% expected and 0.8% in Q1, while the y/y rate came in at 2.9% vs. 2.8% expected and 8.7% in Q1. This was the first q/q drop since Q1 2021. Private consumption and government spending contracted -0.2% q/q and -2.9% q/q, respectively, while GFCF grew 0.6% q/q. Net exports contributed to growth as exports grew 2.4% q/q while imports contracted -1.5% q/q. Looking at the monthly data, GDP came in at -0.6% m/m vs. -1.2% expected and a revised 0.4% (was 0.5%) in May, construction came in at -1.4% m/m vs. -2.0% expected and a revised 1.8% (was 1.5%) in May, IP is came in at -0.9% m/m vs. -1.4% expected and a revised 1.3% (was 0.9%) in May, and services came in at -0.5% m/m vs. -1.0% expected and a revised 0.2% (was 0.4%) in May.

While the data were modestly better than expected, a recession is a foregone conclusion and the only questions are how long and how deep. The BOE sees recession starting in Q4 and lasting five quarters but that is simply their best guess right now. Despite the gloomy macro outlook, the BOE is set to continue tightening . WIRP suggests over 85% odds of a 50 bp hike September 15. Looking ahead, the swaps market is pricing in 150 bp of tightening over the next 12 months that would see the policy rate peak near 3.25%.

Eurozone June IP was reported. It came in at 0.7% m/m vs. 0.2% expected and a revised 2.1% (was 0.8%) in May. This boosted the y/y rate to 2.4% vs. 1.0% expected and 1.6% in May. Last week’s country-level IP data were mixed. Despite the upside surprise for IP, the overarching story for the eurozone is still one of weakness and likely recession. ECB tightening expectations continue to go up and down from week to week. WIRP suggests a 50 bp hike is 80% priced in for September 8. The swaps market is pricing in 150 bp of tightening over the next 12 months that would see the deposit rate peak between 1.5%, up from 1.25% at the start of last week.

Sweden reported July CPI. Headline came in at 8.5% y/y vs. 8.7% expected and actual in June, CPIF came in at 8.0% y/y vs. 8.3% expected and 8.5% in June, and CPIF ex-energy came in as expected at 6.6% y/y vs. 6.1% in June. The Riksbank meets September 20 and WIRP suggests nearly 85% odds of a 75 bp hike. At the last meeting June 30, the Riksbank hiked 50 bp to 0.75%, as expected. Governor Ingves said that if it becomes necessary, the bank will hike by 75 bp but added “At this point our basic assumption is that hiking the rate to somewhere around 2%” will be enough and stressed “if that isn’t enough we will continue increasing the policy rate further until we get inflation down to our target.” The swaps market has a different view and is pricing in 200 bp of tightening over the next 12 months that would see the policy rate peak near 2.75%. With CPIF ex-energy still rising, the Riksbank’s updated rate path should move closer to market pricing.

ASIA

Taiwan revised Q2 GDP growth slightly lower. Growth came in at 3.05% y/y vs. the 3.08% advance reading and 3.72% in Q1. This is the weakest reading snice Q2 2020 and led the government to cut its forecast for 2022 growth a second time. GDP is now expected to grow 3.76% this year, down from 3.91% forecast in May. The government also raised its full-year forecast for inflation to 2.92% vs. 2.67% in May projection. Simply put, Taiwan is struggling with the same problems as the rest of the world. However, policymaker have been very cautious, with the central bank only hiking rates twice so far for a total of 37.5 bp. Next policy meeting is September 22 and another small hike is expected then. The swaps market is pricing in only 25 bp of tightening over the next 6 months that would see the policy rate peak near 1.75%. This seems way too low to us.

India reports July CPI and June IP. CPI is expected at 6.76% y/y vs. 7.01% in June. If so, inflation would be down for the third straight month from the 7.79% peak in April and moving closer to the 3-6% target range. The RBI just hiked rates 50 bp to 5.4% and signaled that the tightening cycle will continue. Governor Das said “Inflationary pressures are broad based and core inflation remains elevated,” noting that inflation will remain above the 2-6% target range for the current FY ending in March. He stressed that “It’s now basically a whatever-it-takes approach going into third year in succession.” Next policy meeting is September 30 and another 50 bp hike then seems likely, with risks of a smaller move if inflation continues to fall. The swaps market is pricing in 120 bp of tightening over the next 12 months that would see the policy rate peak near 6.60%.

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