Dollar Gets Some Traction Ahead of the Weekend

September 20, 2024

Win Thin

The market continues to overestimate Fed easing; growth remains robust in Q3; weekly jobless claims suggest the labor market remains in solid shape; financial conditions continue to loosen; Canada reports July retail sales
BOE kept rates steady at 5.0%, as expected; U.K. reported firm August retail sales data; Turkey is setting the table for a rate cut
BOJ delivered the widely expected hold; Ueda emphasized that financial market are still unstable and upside inflation risks have eased; Japan reported August national CPI; PBOC left the 7-day repo rate unchanged at 1.70%

The dollar is getting some traction ahead of the weekend. DXY is trading higher near 100.812 even as the market continues to overestimate Fed easing potential (see below). The yen is underperforming again as the BOJ delivered a dovish hold (see below), with USD/JPY trading higher just above 144. The euro is trading flat near $1.1160, while sterling is trading flat near $1.3285 after firm retail sales data (see below). Despite the Fed’s efforts to push back in the Dot Plots and Powell’s press conference, market easing expectations have intensified. Yet the U.S. data remain firm and so we continue to believe that the market is once again overreacting and dead wrong in pricing in 225-250 bp of further easing over the next 12 months. Yet we cannot stand in the way of this move and so until market pricing changes, the dollar is likely to remain vulnerable.

AMERICAS

The market continues to overestimate Fed easing. The Fed has tried its best to rein in dovish expectations but the market is still pricing in 75 bp of easing by year-end and 225-250 bp over the next 12 months. This is deep recession pricing and it's simply not happening. We expect Fed officials to push back against the market in the coming days and weeks. Harker speaks this afternoon and will be followed by a full slate of speakers next week. Until the market reprices, we think the dollar will remain vulnerable.

Growth remains robust in Q3. The New York Fed’s Nowcast model is tracking Q3 growth at 2.6% SAAR and Q4 growth at 2.2% SAAR. Both estimates will be updated today. Elsewhere, the Atlanta Fed’s GDPNow model is tracking Q3 growth at 2.9% SAAR and will be updated next Friday after the data. The Fed's updated macro forecasts may be a tad too optimistic but we agree with the directional message; that is, we see a soft landing and avoid recession.

Indeed, weekly jobless claims suggest the labor market remains in solid shape. Initial claims data that were reported yesterday were for the BLS survey week containing the 12th of the month and fell to 219k vs. expectations they would remain steady at 230k. This is the lowest since mid-May, while the 4-week moving average fell to 227.5k, the lowest since early June. Elsewhere, continuing claims are reported with a one-week lag and came in at 1.829 mln vs. 1.850 mln expected and a revised 1.843 mln (was 1.850 mln) last week. This was the lowest since mid-June. There is no Bloomberg consensus yet for September NFP but its whisper number stands at 130k vs. 142k in August.

Financial conditions continue to loosen. The Chicago Fed’s weekly measure through last Friday was the loosest since November 2021, months before the Fed started hiking rates. With U.S. yields down, equity markets up, and the dollar weak, condition are likely to continue loosening this week as well. The Fed is probably very happy that the market is doing most of the heavy lifting, as loose financial conditions should help the economy avoid a hard landing.

Canada reports July retail sales. Headline is expected at 0.6% m/m vs. -0.3% in June, while ex-autos is expected to remain at 0.3% m/m. Statistics Canada’s advanced retail indicator suggests sales increased 0.6% m/m. We believe lower inflation and growing slack in the labor market argue for a 50 bp rate cut at the next meeting October 23. The swaps market currently sees 55% odds of such a cut, up from 35% at the end of last week.

EUROPE/MIDDLE EAST/AFRICA

Bank of England kept rates steady at 5.0%, as expected. The decision to stand pat was backed by a strong 8-1 majority, as only Dhingra supported a 25 bp cut. The BOE reiterated that “monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term had dissipated further.” The BOE also voted to reduce the stock of U.K. government bonds by GBP100 bln over the next 12 months, the same pace as the previous 12 months. The BOE estimates quantitative tightening to have had little impact on gilt yields, the real economy, and market functioning.

U.K. reported firm August retail sales data. Headline came in at 1.0% m/m vs. 0.4% expected and a revised 0.7% (was 0.5%) in July, while sales ex-auto fuel came in at 1.1% vs. 0.5% expected and a revised 1.0% (was 0.7%) in July. The y/y rates improved to 2.5% and 2.3%, respectively. The gains were driven by unseasonably strong food and clothing sales. Better weather and end-of-season sales also contributed to the strong gains.

Turkey central bank is setting the table for a rate cut. It kept rates steady at 50.0% yesterday, as expected, and said “Monetary policy tools will be used effectively in case a significant and persistent deterioration in inflation is foreseen.” However, the statement omitted the pledge for further tightening if needed and also highlighted that domestic demand was cooling along with services inflation. With disinflation continuing slowly, we expect the bank to begin a cautious easing cycle before year-end. We believe the next meeting October 17 is too soon and instead favor a cut at either the November 21 or December 26. The market is pricing in 17 percentage points of easing over the next 12 months, which seems too aggressive given that the pace of disinflation is likely to slow in the coming months due to low base effects.

ASIA

The two-day Bank of Japan meeting ended with the widely expected hold. However, the updated policy guidance and comments from Governor Ueda signaled that the BOJ is in no rush to remove policy accommodation. While Ueda reiterated during his post-meeting press conference the bank’s plans to tighten policy further if the outlook for economic activity and prices is realized, that sentence was omitted in the latest BOJ Statement on Monetary Policy. Instead, the statement warned that considering the risks to the outlook remain high, “it is necessary to pay due attention to developments in financial and foreign exchange markets and their impact on Japan's economic activity and prices.”

Indeed, Ueda emphasized that financial market are still unstable and upside inflation risks have eased. Ueda added there was no schedule for how long it will take to decide on the next hike as the BOJ keeps assessing the impact of the two rate hikes already seen this year. The market is not pricing in the next hike until well into 2025, with only 20-25 bp of total tightening seen over the next 12 months. This seems about right to us and would downplay some recent analyst calls for the next hike in December.

Japan reported August national CPI. Headline CPI inflation came in as expected at 3.0% vs. 2.8% in July y/y, core (ex-fresh food) came in as expected at 2.8% y/y vs. 2.7% in August, and core ex- energy came in as at 2.0% y/y vs. 1.9% in August. September Tokyo CPI data will be reported next Friday. Headline is expected at 2.2% y/y vs. 2.6% in August, core (ex-fresh food) is expected at 2.0% y/y vs. 2.4% in August, and core ex-energy is expected to remain steady at 1.6% y/y. If so, it would be a big reversal of the recent rise in inflation and reinforces our doubts that the BOJ will tighten more than is currently priced in.

The People’s Bank of China left the 7-day repo rate unchanged at 1.70%. Commercial banks also kept the 1- and 5-year loan prime rates steady at 3.35% and 3.85%, respectively. The bank sets its 1-year MLF rate next Wednesday. This has been delayed from mid-month as the PBOC engineers a transition in the policy rate from the 1-year MLF to the 7-day reverse repo rate. After China reported soft August money and new loan data as well as weak real sector data, we expect further stimulus in the coming weeks and months. However, China’s huge debt overhang (around 300% of GDP) will blunt the effectiveness of monetary policy in boosting growth. Same goes for ending restrictions on home purchases, which reports suggest another round of loosening limits is being considered.

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