Dollar Recovers from Post-Data Sell-off

August 24, 2022
  • The Jackson Hole Economic Symposium begins tomorrow; Kashkari remains hawkish and also made some rare comments about the dollar; S&P Global preliminary August PMI readings came in weak; housing data will be closely watched; Mexico and Brazil report mid-August inflation data
  • ECB officials are acknowledging the risks of recession; South Africa reported July CPI
  • Japan will end its requirement for boosted inbound travelers to show a negative Covid test result to enter; Bank of Thailand Governor Sethaput aims to keep its tightening cycle gradual

The dollar has recovered nicely from yesterday’s post-data sell-off. DXY is trading near 108.75 after testing the 108 area yesterday. We believe it remains on track to test the July 14 high near 109.294. The euro remains heavy after yesterday’s bounce really couldn’t crack $1.00 and is currently trading near $0.9930. We believe it remains on track to test the September 2002 low near $0.9615. Sterling also remains heavy near $1.1780 and remains on track to test the March 2020 low near $1.1410. USD/JPY traded as high as 137.70 yesterday but has since fallen back to around 136.60. This pair remains on track to test the July 14 high near 139.40. We maintain our strong dollar call as the dollar smile seems intact. As risk-off impulses ebb and flow, the dollar should continue to benefit from the relatively strong U.S. economic outlook and heightened Fed tightening expectations.

AMERICAS

The Kansas City Fed’s Jackson Hole Economic Symposium begins tomorrow. We will be putting out a preview later today. Bottom line: we expect no surprises as the Fed is likely to maintain its hawkish posture ahead of the September 20-21 FOMC meeting. Fed tightening expectations remain steady despite the weak data yesterday. WIRP suggests a 50 bp hike is fully priced in for the September 20-21 FOMC meeting, with nearly 60% odds of a 75 bp hike. Looking ahead, the swaps market is still pricing in a 3.75% terminal rate vs. 3.5% at the start of last week. U.S. rates continue to edge higher, with the 2-year yield trading near 3.30% and the 10-year near 3.04%.

Ahead of Jackson Hole, Kashkari remains hawkish. Yesterday, he noted that “By many, many measures we are at maximum employment and we are at very high inflation. So this is a completely unbalanced situation, which means to me it’s very clear: We need to tighten monetary policy to bring things into balance.” Kashkari added that “When inflation is 8% or 9%, we run the risk of unanchoring inflation expectations and leading to very bad outcomes that would cause us to have to be very aggressive -- Volcker-esque -- to then re-anchor them.” Kashkari saw some positive developments on the supply side, which he said accounts for roughly two thirds of the current high inflation, with fiscal stimulus and Fed policy accounting for the remaining third.

Kashkari made some rare comments about the dollar. Because dollar policy is run by Treasury, Fed officials can’t say anything beyond the obvious impact of the exchange rate on inflation. Kashkari stayed in his lane when asked if the stronger dollar would impact Fed policy, stressing that the bank is setting policy for purely domestic considerations. That said, he acknowledged “What does a strong dollar mean for inflation? That may then mean that we have to do less because it may bring down the price of imports.” We note that the strong currency is a typical by-product of a tightening cycle and is yet another channel through which the Fed can impact inflation. However, the exchange rate is never a target of any sort for the Fed.

S&P Global preliminary August PMI readings came in weak. Manufacturing came in at 51.3 vs. 51.8 expected and 52.2 in July vu the big surprise was services, which came in at 44.1 vs. 49.8 expected and 47.3 in July. As a result, the composite plunged to 45.0 vs. 47.7 in July. The huge drop in services is very surprising and a bit hard to explain. The ISM PMIs carry a bit more weight in the markets but they won't be reported until September 1 and 6, respectively. Of note, the ISM and S&P Global manufacturing PMIs have been tracking pretty closely but the services PMIs are diverging significantly. In July, S&P Global had it at 47.3 vs. 56.7 for ISM, an almost 10 point difference. Will ISM play some catchup in August or will the divergence be maintained? Given how firm the US data have remained, we have to put more weight on the ISM measures as it's hard to reconcile S&P Global readings in the mid-40s with what's being seen in consumption, employment, and other hard data.

Regional Fed manufacturing surveys for August continue rolling out. Richmond Fed came in at -8 vs. -2 expected and 0 in July. Kansas City reports tomorrow and is expected at 9 vs. 13 in July. July durable goods orders will be reported today and are expected at 0.8% m/m vs. 2.0% in June. Of note, core orders (non-defense ex-aircraft) are expected at 0.3% m/m vs. 0.7% in June. We note that the manufacturing PMIs remain firm, suggesting that this sector remains resilient.

Housing data will be closely watched. Pending home sales will be reported today and are expected at -2.5% m/m vs. -8.6% in June. Yesterday, July new home sales came in at -12.6% m/m vs. -2.5% expected and a revised -7.1% (was -8.1%) in June. It's worth noting that there is now a 10.9 month supply of new home inventory, the highest since March 2009 and nearing the 12.2 month peak from January 2009. Of note, shelter accounts for 35% of CPI and nearly 20% of PCE; while shelter costs are still rising, at some point, this excess supply of housing will push prices down significantly and help lower core inflation. This is exactly what the Fed wants.

Mexico reports mid-August CPI. Headline is expected at 8.55% y/y vs. 8.16% in mid-July. If so, inflation would be the highest since December 2000 and further above the 2-4% target range. Banxico minutes will be released tomorrow. At the August 11 meeting, the bank hiked rates 75 bp to 8.5%, as expected. The decision was unanimous but the bank said future moves will depend on prevailing conditions. Perhaps the minutes will provide more clues. Net policy meeting is September 29 and another 75 bp hike seems likely. The swaps market is pricing in 125-150 bp of tightening over the next 6 months that would see the policy rate peak between 9.75-10.0%.

Brazil reports mid-August IPCA inflation. 9.49% y/y vs. 11.39% in mid-July. If so, it would be the lowest since mid-August 2021 but still above the 2-5% target range. At the last meeting August 3, COPOM hiked rates 50 bp to 13.75% and said "The committee will evaluate the need for a residual adjustment, of lower magnitude, in its next meeting." That policy meeting is September 21 and the swaps market is pricing in 50% odds of one last 25 bp cut then. However, with price pressures likely to remain high due to increased fiscal spending ahead of October elections, we do not think there will be a quick pivot to an easing cycle in H1 2023 that is priced in now.

EUROPE/MIDDLE EAST/AFRICA

European Central Bank officials are acknowledging the risks of recession. Panetta noted that “If we will have a significant slowdown or even a recession, this would mitigate inflationary pressures.” He stressed that monetary policy “needs to be strictly data dependent, taking fully into consideration the condition of the euro-area economy. This implies first of all to be fully aware that the probability of a recession is increasing in the euro area because of the consequences of the pandemic, of the shock to commodity prices of recent months, because of the war and its consequences for trade and uncertainty.” At face value, this seems to be a bit dovish but for now, it seems to be full speed ahead for the ECB. WIRP suggests a 50 bp hike is fully priced in for September 8, with around 20% odds of a larger 75 bp move. The swaps market is pricing in 200 bp of tightening over the next 12 months that would see the deposit rate peak near 2.0%, up from 1.75% at the start of last week.

South Africa reported July CPI. Headline came in as expected at 7.8% y/y vs. 7.4% in June, while core came in a tick higher than expected at 4.6% y/y vs. 4.4% in June. Headline is the highest since May 2009 and further above the 3-6% target range. PPI will be reported tomorrow. At the last policy meeting July 21, SARB delivered a hawkish surprise and hiked rates 75 bp to 5.5% vs. 50 bp expected. The vote was 3-1-1, with one dissent in favor of a 50 bp hike and one in favor of a 100 bp hike. Its model now sees the policy rate at 5.61% by year-end vs. 5.3% previously, at 6.45% by end-2023 vs. 6.21% previously, and at 6.78% by end-2024 vs. 6.74% previously. Next policy meeting is September 22 and a 50 bp hike seems likely then, with some risks of another hawkish surprise. Of note, the swaps market sees 200 bp of tightening over the next 12 months that would take the policy rate up to 7.5%, which is much more hawkish than the SARB’s expected rate path.

ASIA

Japan will end its requirement for boosted inbound travelers to show a negative Covid test result to enter the country. This will go into effect September 7. Prime Minister Kishida added that the government will decide soon whether to raise the daily entry limit from the current 20,000 travelers, with reports suggest it might raise the level to 50,000. With the economy showing signs of slowing, it’s clear that policymakers are looking to boost tourism in the coming months. Of note, the weak yen should help promote foreign visitors. Recent softness in the data supports our view that BOJ policymakers will not change policy anytime soon.

Bank of Thailand Governor Sethaput aims to keep its tightening cycle gradual. He noted that the chances that the bank will hike aggressively is low but if there is any evidence of a wage-price spiral, it can adjust the pace of rate hikes. He said the bank will stick with its “gradual and measured” path even as others are hiking more aggressively, adding that “If we see economic conditions warrant that we pause, we will pause. If it warrants a larger hike, like a 50-basis point hike we will do so.” Sethaput noted that inflation is “uncomfortably high” but stressed that it’s mostly supply-driven and should fall back to the 1-3% target range by mid-2023 as commodity prices fall. Sethaput said he’s watching the rising trend in core inflation and looking for any signs of demand-led price pressures. The bank just started hiking this month and the swaps market is pricing in 150 bp of tightening over the next 24 months that would see the policy rate peak near 2.25%.

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