• The Fed delivered the widely expected hold; Powell’s press conference provided the dovish goods; financial conditions are already loose and about to get even looser; ADP came in soft; July ISM manufacturing PMI will be the data highlight; Chile delivered a hawkish surprise
  
• BOE meeting ends shortly with an expected 25 bp cut to 5.0%; BOE July DMP inflation expectations will be reported; Czech Republic is expected to cut rates 25 bp to 4.50%
  
• Japan stocks fell the most since 2020 in the wake of the BOJ hike; Caixin reported soft July manufacturing PMI; Korea reported July trade data; crude oil prices continue to move higher on fears of a broader regional conflict in the Middle East

The dollar is trading firm as risk off impulses build ahead of the BOE decision. Due to concerns about a wider regional conflict in the Middle East, DXY has nearly recouped all of yesterday’s losses and is trading near 104.402. Despite the dovish hold from the FOMC (see below), the dollar smile remains intact. CHF is the best major performer due to the haven bid, while NOK is outperforming on higher oil prices. Sterling is trading lower near $1.2775 ahead of the expected BOE cut shortly, while the euro is trading lower near $1.0785. While the Fed is expected to cut rates in September, recent firmness in the U.S. data suggests the market is once again getting carried away with its pricing for aggressive easing (see below). Beyond just the U.S. story, we continue to believe that the divergence story remains in place and should continue to support the dollar.

AMERICAS

The two-day FOMC meeting ended with the widely expected hold. The statement reiterated that it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.” The Fed noted that inflation made some progress but remains “somewhat” elevated. On the other hand, it’s also very clear that the Fed is increasingly concerned about the labor market, as the statement emphasized it “is attentive to the risks to both sides of its dual mandate; previously, the FOMC statement noted it was “highly attentive to inflation risks.”

Chair Powell’s press conference provided the dovish goods. To wit, Powell said that “a reduction in our policy rate could be on the table as soon as the next meeting in September.” For emphasis, he added that “there was a real discussion back and forth of what the case would be for moving at this meeting.” Concern about the labor market is palpable, as Powell noted that he “would not like to see material further cooling in the labor market.” The implication is that tomorrow’s jobs report will be a significant driver of interest rate expectations.

The market continues to price in a dovish Fed rate path. A 25 bp cut in September is fully priced in, with some small odds seen of a larger 50 bp cut. Furthermore, nearly 75 bp of easing by year-end is priced in, as well as 150 bp of total easing over the next 12 months. In our view, solid US economic activity and modest disinflation suggest the Fed is unlikely to cut rates as much as is currently priced in. As such, there is room for an upward reassessment in Fed Funds expectations that favor higher USD and Treasury yields.

Financial conditions are already loose and about to get even looser. Through last Friday, Chicago Fed financial conditions were the loosest since mid-November 2021. As markets gear up for the Fed to cut in September, conditions are likely to continue loosening.

ADP private sector jobs came in soft. The headline of 122k fell short of 150k expected. Service-providing jobs rose 85k and goods-producing jobs rose 37k. However, we note that NFP has outperformed ADP two straight months and 10 of the past 11. For NFP tomorrow, Bloomberg consensus sees 175k vs. 206k in June, while its whisper number stands at 177k. For reference, the average non-farm payrolls monthly gain over the past 12 months is 220k.

July ISM manufacturing PMI will be the data highlight. Headline is expected at 48.8 vs. 48.5 in June. Prices paid is expected at 51.8 vs. 52.1 in June, new orders are expected at 49.0 vs. 49.3 in June, and employment is expected at 49.2 vs. 49.3 in June. S&P Global manufacturing PMI fell to a 7-month low of 49.5 in June vs. 51.6 in June. Yesterday, the Chicago PMI came in at 45.3 vs. 45.0 expected and 47.4 in June. However, it has been a terrible predictor of the national PMI readings for going on two years now.

Other labor market data will be reported. July Challenger job cuts, Q2 nonfarm productivity and unit labor costs, and weekly jobless claims will also be reported. Nonfarm productivity (GDP/hours worked) is expected at 1.8% q/q vs. 0.2% in Q1, while ULC is expected at 1.7% q/q vs. 4.0% in Q1. Importantly, annual productivity growth is running above its post-war average of 2.1%. Rising productivity leads to low inflationary economic growth which translates to higher real interest rate and an appreciation in the currency over the longer term.

The U.S. economy remains robust even as price pressures continue to ease slowly. The Atlanta Fed’s GDPNow model’s initial estimate for Q3 growth came in at 2.8% SAAR and will be updated today after the data. Elsewhere, the New York Fed’s Nowcast model is tracking Q3 growth at 2.7% SAAR and will be updated tomorrow. Its initial estimate for Q4 growth will come at the end of August. Bottom line: above trend growth means the Fed won’t cut rates aggressively.

Chile central bank delivered a hawkish surprise. It kept rates steady at 5.75% vs. an expected 25 bp cut to 5.5%. The decision was unanimous, which was surprising since the vote to cut rates 25 bp back in July was 4-1, with the dissent in favor of a larger 50 bp move then. Yesterday, the bank stressed that the policy rate will continue to fall but added that the bulk of the easing was already seen in H1 of this year. Headline inflation has accelerated three straight months to 4.2% y/y, the highest since February and above the 2-4% target range, and so caution is warranted. The market is still pricing in 75 bp of easing over the next 12 months.

EUROPE/MIDDLE EAST/AFRICA

Bank of England meeting ends shortly with an expected 25 bp cut to 5.0%. However, there is scope for heightened volatility as nearly a quarter of the 41 analysts polled by Bloomberg see steady rates and the swaps market implies 60% odds of a hike. We expect the BOE to cut the policy rate 25 bp, in large part because headline CPI inflation has been at the BOE’s 2% target the last two months. Granted, services CPI inflation is still running high at 5.7% y/y, but forward-looking indicators point to a sharp slowdown in H2. In July. In June, the vote to stay on hold was 7-2 with the 2 dissents favoring a cut. As such, a rate cut today needs the support of just 3 more MPC members. Updated macro forecasts will be released, while both Bailey and Pill speak.

BOE July DMP inflation expectations will be reported. Expectations had been falling steadily but seem to have bottomed out in recent months. However, we do not think this is enough to derail a cut today.

Czech National Bank is expected to cut rates 25 bp to 4.50%. At the last meeting June 27, the delivered a dovish surprise and cut rates 50 bp to 4.75% vs. 25 bp expected. However, Governor Michl said then that the pace of easing was likely to slow in the coming meetings and added that next move was likely to be either a 25 bp cut or a pause. The swaps market is pricing in 100 bp of total easing over the next 12 months.

ASIA

Japan stocks fell the most since 2020 in the wake of the BOJ hike. The Topix fell -3.2% on the day, while the Nikkei 225 fell -2.5%. At the root of the problem is the strong yen, which traded as low as 148.50 today, the lowest since mid-March. Exports and tourism are at great risk from the strong yen, but markets are also left wondering whether the broader economy can withstand this shock. Even before this week’s actions and reactions, economic data had been softening.

Caixin reported soft July manufacturing PMI. Headline came in at 49.8 vs. 51.5 expected and 51.8 in June. We believe the Caixin PMIs have been overstating growth in China and will eventually move towards the weaker official readings that are likely closer to the mark. Indeed, the weak economy clearly led the PBOC to unexpectedly cut rates last week. Caixin services and composite PMIs will be reported Monday.

Korea reported July trade data. Exports came in at 13.9% y/y vs. 18.4% expected and 5.1% in June, while imports came in at 10.5% y/y vs. 13.4% expected and -7.5% in June. While both continue to recover, much of it is due to low base effects, which will fade in the coming months. Along with the weak mainland China outlook, this suggests regional trade and activity remains at risk.

COMMODITIES

Crude oil prices continue to move higher on fears of a broader regional conflict in the Middle East. Iran has vowed revenge after Israel assassinated the political leader of Hamas in Tehran and killed a senior member of Hezbollah in Beirut. It's been pretty amazing how markets have been able to basically overlook two running ground wars that are always at risk of turning into three (or more), and so there will always be developments and headline risks that impact energy prices. Nevertheless, China’s sluggish growth outlook remains a structural headwind for commodity prices overall.