• A sense of relative calm has returned to the markets; Fed officials are trying to inject some calm into markets; July ISM services PMI was solid; Fed’s SLOOS was released; Canada reports July S&P Global services and composite PMIs; Brazil central bank minutes will be released
  
• Germany reported June factory orders; eurozone reported soft June retail sales; U.K. BRC retail sales data firmed modestly
  
• Japan policymakers sought to calm markets; Japan reported strong June cash earnings; RBA delivered a hawkish hold; Philippines July CPI ran hot

The dollar is recovering as some calm returns to the markets. DXY is trading higher near 103.13 after two straight down days. The yen is the worst performing major and is trading back above 145 after trading as low as 141.70 yesterday. Sterling is also underperforming and trading lower near $1.2700, while the euro is trading lower near $1.09 after trading above $1.10 yesterday. While the Fed is expected to cut rates in September, we continue to believe that markets are overreacting to the recent softness in the U.S. data. Looking at the totality of the data, the economy is still growing above trend and suggests the market is once again getting carried away with its pricing for aggressive easing (see below). We continue to believe that the divergence story remains in place and should continue to support the dollar. However, it will likely take weeks for the current market narrative to run its course.

AMERICAS

A sense of relative calm has returned to the markets. However, we are by no means out of the woods. Asian equity markets recovered, but European bourses are in the red. Elsewhere, UST yields have risen a bit but remain near this week’s lows, while EM FX remains under pressure. Until we get more definitive data showing that the U.S. is not sliding into recession, we expect heightened volatility across all markets as fear dominates. A sustained recovery in sentiment will likely have to wait until next week, when the U.S. reports July retail sales Thursday. July PPI Tuesday and CPI Wednesday should help calm markets as well.

We continue to believe that the market is once again overreacting to one data point. To wit, the market is fully pricing in 100 bp of easing by year-end, with nearly 55% odds of another 25 bp on top of that. This incorporates nearly 90% odds that the Fed’s first cut in September will be 50 bp. Looking further ahead, the market is pricing in over 200 bp of total easing over the next 12 months. Unless the U.S. economy falls into a deep recession, this rate path seems unlikely. However, we cannot stand in the way of this dovish narrative until we see more data.

Fed officials are trying to inject some calm into markets. Goolsbee echoed his Friday remarks yesterday in noting “As you see jobs numbers come in weaker than expected but not looking yet like recession, I do think you want to be forward looking of where the economy is headed for making the decisions.” However, Goolsbee also stressed that “The Fed’s job is very straightforward, maximize employment, stabilize prices and maintain financial stability. So if the conditions collectively start coming in that on the through line, there’s deterioration on any of those parts, we’re going to fix it.” Daly said “Policy adjustments will be necessary in the coming quarters. We have now confirmed that the labor market is slowing, and it is extremely important that we not let it slow so much that it tips itself into a downturn.” However, Daly stressed that “We have a reasonably solid labor market. Underneath the hood of the labor market report, there’s a little more room for confidence - confidence that we’re slowing but not falling off a cliff.”

July ISM services PMI was solid. Headline came in at 51.4 vs. 51.0 expected and 48.8 in June. Activity came in at 54.5 vs. 49.6 in June, while employment came in at 51.1 vs. 46.1 in June. Prices paid came in at 57.0 vs. 56.3 in June, mirroring the modest rise in the same component in the ISM manufacturing PMI. All in all, this was a good report with strong details. Not a blockbuster by any means, but certainly not pointing to recession either. As we've been saying, we don't think ISM alone can turn the tide and we will need to see stronger data next week to drive home the message that markets are overreacting to last week’s jobs report.

The U.S. economy overall remains solid. Yes, there are pockets of weakness, but GDP grew 2.8% SAAR in Q2. For Q3, the Atlanta Fed’s GDPNow model is tracking 2.5% SAAR and will be updated today after the June trade data. The New York Fed’s Nowcast model is tracking Q3 growth at 2.1% SAAR and will be updated Friday. Its first estimate for Q4 will come at the end of August.

The Fed’s Senior Loan Officer Opinion Survey was released. The net share of banks tightening credit standards in Q2 for large and medium firms fell to 7.9% vs. 15.6% in Q1 and was the lowest since Q2 2022. In terms of credit standards, we are basically back to where we were when the Fed started hiking rates. There was a similar trend in credit standards for small firms, where the net share fell to 8.2% vs. 19.7% in Q1, as well as for credit cards, where the net share fell to 20% vs. 21.2% in Q1.

Canada reports July S&P Global services and composite PMIs. Last week, its manufacturing PMI came in at 47.8 vs. 49.3 in June. Ivey PMI will be reported tomorrow.

Brazil central bank minutes will be released. At last week’s meeting, the bank kept rates steady at 10.5% and noted that it sees unanchored inflation estimates as well as resilience in economic activity. It warned that it’s closely following fiscal developments even as several core inflation gauges remain above target. Yet despite these risks, the bank gave no hint that it was getting ready to hike rates. The swaps market is pricing in the start of the tightening cycle over the next three months and 125 bp of total tightening over the next 12 months. Of note, July IPCA inflation will be reported Friday. Headline is expected at 4.47% y/y vs. 4.23% in June. If so, it would accelerate for the third straight month to the highest since February and near the top of the 1.5-4.5% target range.

EUROPE/MIDDLE EAST/AFRICA

Germany reported June factory orders data. Orders came in at 3.9% m/m vs. 0.5% expected and a revised -1.7% (was -1.6%). However, the y/y rate still plunged to -11.8% vs. -14.2% expected and a revised -8.7% (was -8.6%) in May. Trade data will be reported tomorrow. Exports are expected at -1.5% m/m vs. -3.6% in May, while imports are expected at 2.3% m/m vs. -7.0% in May. IP will also be reported Wednesday and is expected at -4.2% y/y vs. -6.7% in May.

Eurozone reported soft June retail sales. Headline came in at -0.3% m/m vs. -0.1% expected and 0.1% in May, while the y/y rate fall to -0.3% vs. 0.1% expected and a revised 0.5% (was 0.3%) in May. In y/y terms, June retail sales in France and Italy fell -0.7% and -1.0%, respectively, while Spain’s rose 0.3%. Germany has not reported May or June sales data yet, but we would expect significant weakness to come.

Weak data should keep the ECB in easing mode. Next meeting is September 12 and a 25 bp cut is fully priced in, with follow up cuts at the October and December meetings. Looking further ahead, the swaps market is pricing in 150 bp of total easing over the next 12 months.

U.K. BRC retail sales data firmed modestly. Same store sales recovered 0.3% y/y in July vs. 0.2% expected and -0.5% y/y in June. This suggests retail sales may also recover from -0.2% y/y in June when the data are reported August 16. Overall, the recovery in U.K. real incomes and rising consumer confidence are expected to support consumption growth. This suggests the bar for an aggressive Bank of England easing cycle is high.

ASIA

Japan policymakers sought to calm markets. Officials from Japan’s Ministry of Finance, the Bank of Japan and the Financial Services Agency held a three-way meeting today to discuss recent market action, the first such meeting since March. Nothing specific was announced. Instead, new Vice Finance Minister for International Affairs Mimura said the government agreed with the BOJ to closely monitor developments in the economy and financial markets with a sense of urgency. Prime Minister Kishida later added that “It’s important to make calm judgments in a situation like this. I want to continue to watch the situation with a sense of urgency while closely cooperating with the Bank of Japan.”

Japan reported strong June cash earnings data. Nominal earnings came in at 4.5% y/y vs. 2.4% expected and 2.0% in May, while real earnings came in at 1.1% y/y vs. -0.9% expected and -1.3% in May. This was the first positive reading for real earnings since March 2022. Lastly, scheduled full-time earnings came in at 2.7% y/y vs. 2.9% expected and 2.7% in May. The improving wage dynamic validates the Bank of Japan’s guidance to tighten policy further.

Monetary policy repricing isn't just limited to the U.S. What's most interesting is that the BOJ is now only expected to hike 15 bp over the next 12 months, down from 50 bp expected right after its hawkish hike. Looking further out, only 35 bp of total tightening is seen over the next 3 years. That's quite the dovish pivot.

Reserve Bank of Australia delivered a hawkish hold. It kept rates steady at 4.35% and reiterated that “the Board is not ruling anything in or out” and “that it will be some time yet before inflation is sustainably in the target range.” The RBA also warned again of “the need to remain vigilant to upside risks to inflation.” The RBA is clearly in no rush to loosen policy. First, the updated macro forecast show inflation to be more persistent. Trimmed mean and headline CPI inflation are now expected to approach the midpoint of the 2-3% band in December 2026 vs. June 2026 in the May forecasts. Second, Governor Bullock pointed out during her press conference that “the Board did consider a rate rise” and that rate cuts are “not in the agenda in the near-term.” Bullock added that expectations for rate cuts are “a little ahead of themselves.” The market reaction was swift, Australian interest rate futures went from pricing almost 50 bp cuts by year-end to 25 bp. Bullock speaks again Thursday.

Philippines July CPI ran hot. Headline came in at 4.4% y/y vs. 4.1% expected and 3.7% in June. This was the highest since October and back above the 2-4% target range. At the last meeting June 27, the central bank delivered a dovish hold as Governor Remolona said, “The balance of risks to the inflation outlook has shifted to the downside for 2024 and 2025 due largely to the impact of lower import tariffs on rice.” He added that this makes an August rate cut somewhat more likely than before and that a total 50 bp of easing this year was possible. Next meeting is August 15, and no change is expected as inflation picked up. Of note, the market is pricing in 175 bp of easing over the next six months, which seems highly unlikely.