Dollar Remains Firm Ahead of PPI Data

July 14, 2021
  • The growing hawkishness of many central banks globally is fully on display this month; U.S. inflation readings will remain in focus; U.S. Treasury completed its note and bond issuance for the week; the Fed releases its Beige Book report for the upcoming FOMC meeting; Chair Powell testifies before the House today and the Senate tomorrow; BOC is likely to taper again; Chile is expected to hike rates 25 bp to 0.75%
  • U.K. reported higher than expected June CPI; Turkey is expected to keep rates steady at 19.0%
  • RBNZ announced that QE will end this month; the lockdown in Sydney was extended for another two weeks until at least July 30; South Korea’s unemployment rate ticked lower to just 3.7% in June

The dollar remains firm ahead of PPI data. DXY made a marginal new high for this move near 92.829 earlier but stalled just ahead of the July 7 peak near 92.845. Further gains are expected and a break above that high would set up a test of the March 31 high near 93.437. The euro remains heavy after the ECB’s dovish tilt and the break below $1.18 sets up a test of the March 31 low near $1.1705. Sterling is holding up a bit better after higher than expected inflation data (see below) but we think growing concerns about the reopening will eventually push it lower to test the July 8 low near $1.3740. USD/JPY remains bid and a break above 110.85 is needed to set up a test of the July 2 high near111.65.

AMERICAS

The growing hawkishness of many central banks globally is fully on display this month. Just today, the RBNZ announced QE will end this month. More evidence will be seen later today with Canada and Chile both expected to tighten. It seems clear that the world is on a two-track recovery, which is leading to what we view as a widening divergence in economic performances and central bank policies. Those divergences should be the primary driver for FX markets in H2. The greatest debate is clearly over what the Fed does in the coming months, and we continue to believe that tapering here is coming sooner rather than later. This can be thought of in terms of risk management for the Fed. Why not take the foot off the gas a bit? This falls far short of tapping the brakes but it seems prudent to us given the heightened uncertainties regarding inflation. We continue to believe that the central bank divergence story favors the dollar.

U.S. inflation readings will remain in focus. Yesterday, June CPI came in much higher than expected, with headline rising 5.4% y/y vs. 4.9% expected and 5.0% in May and core rising 4.5% y/y vs. 4.0% expected and 3.8% in May. Along with another huge gain in used cars and trucks (10.5% m/m), outsized gains were seen in food (0.8% m/m) and apparel (0.7%). This is the fourth month of upside inflation surprises and so the transitory argument is getting harder and harder to sustain. This is no longer about low base effects, as those dropped out after May as the economy started to recover last spring. The 3-month annualized rates of inflation are 10.3% for headline CPI and 9.6% for core CPI. In other words, inflation is accelerating beyond base effects.

June PPI will be reported today. Headline inflation is expected to rise a tick to 6.7% y/y and core inflation is expected to pick up three ticks to 5.1% y/y. There are upside risks to the PPI data, to state the obvious. There are also upside risks to the Fed's preferred inflation measure of core PCE. That will be reported July 30 and will clearly see acceleration from 3.4% y/y in May. That was the highest reading since April 1992 but June should easily top that and move closer to a 4-handle, something we haven't seen since January 1991.

U.S. yields reacted as one might expect. The 10-year rose to 1.41%, the highest since July 6, but has since leveled out at 1.40%. Similarly, the 10-year breakeven rate rose to 2.38%, the highest since June 16. More importantly, the 2-year yield, which is more sensitive to Fed policy, rose to 0.25%, the highest since June 25 and nearing the cycle high of 0.28% from June 18. The fact that U.S. yields haven’t risen further may be chalked up to the notion that markets believe the Fed has inflation under control.

U.S. Treasury completed its note and bond issuance for the week. Treasury auctioned $24 bln of 30-year bonds yesterday at a yield of 2.0% vs. 2.172% at the previous auction. Indirect bidders (the proxy for foreign demand) accounted for 61.1% vs. 64.0% previously, while the bid-to-cover ratio was 2.19 vs. 2.29 previously. The metrics were in line with the auctions Monday, when a total of $58 bln and $38 bln of 3- and 10-year notes were sold. Then, indirect bidders took 53.2% vs. 54.2% previously for the 3-year and took 63.5% vs. 65.0% previously for the 10-year. Bid-to-cover ratios were 2.41 vs. 2.47 previously and 2.39 vs. 2.58 previously for the two issues, respectively. It appears investor appetite for USTs remains solid even though yields are materially lower than the last auctions in late June.

The Fed releases its Beige Book report for the upcoming FOMC meeting. Since the last one was released June 2, the data have come in mixed. We know hiring has recovered, but remains spotty. The Fed may highlight hiring shortfalls in some areas as well as the fact that it appears to be driven more by labor supply than labor demand. Indeed, many U.S. firms continue to have trouble finding workers. Manufacturing activity appears to be slowing, but continues to expand as survey readings remain at historically elevated levels. Ongoing supply bottlenecks are also likely to figure prominently in the report. We believe the Fed narrative still warrants further tapering discussions at the July 27-28 FOMC meeting .

Chair Powell testifies before the House today and the Senate tomorrow. His views are widely known right now but we suspect some lawmakers will try to pin him down on the tapering timeline. Powell is likely to maintain maximum flexibility in his testimony, but we continue to expect something more definitive at either the August Jackson Hole Symposium or the September 21-22 FOMC meeting if the U.S. data continue to run hot. Kashkari speaks today. Yesterday, Daly said it’s appropriate to start talking about tapering, adding that the Fed is in a good position to taper at the end of this year or early next year. We think more and more on the FOMC are gravitating towards this stance. Tapering to us is taking the foot off the gas while hiking rates is tapping on the brakes, and there is a big difference between the two.

Bank of Canada is likely to taper again. There will be updated macro forecasts at today’s meeting. After starting to taper at the April 21 meeting, the bank opted not to change anything at the next meeting June 9. However, the bank said then that it will adjust the QE program based on its “ongoing assessment of the strength and durability of the recovery.” That suggests further tapering is in the cards as the recovery continues. We expect another round of tapering now, but given the mixed June jobs report that followed two straight months of job losses, it's going to be close call. Ahead of the decision, May manufacturing sales will be reported this morning.

Chile central bank is expected to hike rates 25 bp to 0.75%. There is a long way to go before Chile catches up with Brazil, and it will still lag Mexico initially. But a tightening cycle now could help shore up confidence in the peso ahead of the difficult period of political uncertainty that lies ahead. Bloomberg consensus sees 25 bp of tightening in Q3 and another 50 bp in Q4 that would take the policy rate to 1.25% by year-end, followed by more hikes that take the rate to 2.0% by mid-2022 and between 2.25-2.5% by end-2022. We suspect the peso will have a hard time getting traction in the near term, especially ahead of the presidential primary elections this weekend.

EUROPE/MIDDLE EAST/AFRICA

U.K. reported higher than expected June CPI data. Headline and CPIH inflation were both expected to rise a tick to 2.2% y/y but instead rose to 2.5% and 2.4%, respectively. Core was expected to remain steady at 2.0% y/y but instead rose 2.3%. The headline reading is the highest since August 2018 and the BOE has forecast it will likely exceed 3%. However, with perhaps the exception of recently departed Chief Economist Haldane, most MPC members see elevated inflation as transitory. At the last decision June 24, the bank delivered a dovish hold, warning against “premature tightening” due to its view that the spike in inflation is temporary, noting that “Financial market measures of inflation expectations suggest that the near-term strength in inflation is expected to be transitory.” The bank reiterated then that it does not intend to hike rates until inflation has risen above the 2% target for a sustained period. If inflation continues to surprise to the upside, the BOE will surely be tested. Next BOE decision is August 5 and it may have to pivot back to a more hawkish tone then in light of the recent data. Labor market data will be reported tomorrow, with average weekly earnings expected to pick up significantly.

Turkey central bank is expected to keep rates steady at 19.0%. June CPI came in higher than expected at 17.53% y/y, the highest since May 2019 and further above the 3-7% target range. With the lira remaining vulnerable, a cut at this meeting would be a disaster, though this hasn’t stopped President Erdogan for calling for one either this month or next. Bloomberg consensus sees the policy rate between 18.25-18.50% in Q3, 15.75% by year-end, between 13.0-13.25% by mid-2022, and 13.0% by end-2022.

ASIA

Reserve Bank of New Zealand announced that QE will end this month. Rates were kept steady at 0.25%, with the bank saying it sees the need for ongoing monetary support. At the same time, the RBNZ said that more persistent inflation pressures are expected to build and that the recent rise in house prices is unsustainable. Given the balance of risks, the RBNZ said its “least regret” policy is to withdraw stimulus sooner rather than later. Market pricing for the first hike has shifted from being 80% priced in at the Nov 24 meeting to now being 80% priced in for the Oct 6 meeting. There’s also a material chance the first hike comes August 18. At the last meeting May 26, the bank resumed its practice of publishing its cash rate forecasts after a pause of more than a year. The expected rate path saw the average OCR rising to 0.67% by end-2022, implying 1-2 hikes, and then to 1.78% by mid-2024, the end of the forecast period. New forecasts and projections will be released at the next meeting August 18 and the expected rate path will clearly be moved forward significantly.

The lockdown in Sydney was extended for another two weeks until at least July 30. The outbreak has also spread to Melbourne, the second largest city, as Australia now pays a price for its low vaccination rate. One local bank estimates that each week of Sydney’s lockdown costs the Australian economy AUD1 bln ($744 mln). Australia reported July Westpac consumer confidence at 108.8 vs. 107.2 in June but we see downside risks ahead of the lockdowns continue. Tomorrow, it reports June jobs data.

South Korea’s unemployment rate ticked lower to just 3.7% in June.  However, the new pandemic wave is muddling the outlook for the recovery. Of note, the participation stood at 63%, which is well off the pandemic low of 61.6%, but still far from pre-pandemic levels. As in other countries, hiring in the construction side is helping to offset lack of demand in services. But in the end, it’s the public sector that’s propping up the labor market, and will continue to do so with the latest expansionary budget. Recall that Seoul went into a partial lockdown recently as case numbers accelerated.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2021. All rights reserved.

This browser is not fully supported by our public website and may not display or function as expected for this reason. Please note, the Infuse Portal and BBH client applications fully support the IE 11 browser.

Important Information for Non-U.S. Residents

You are required to read the following important information, which, in conjunction with the Terms and Conditions, governs your use of this website. Your use of this website and its contents constitute your acceptance of this information and those Terms and Conditions. If you do not agree with this information and the Terms and Conditions, you should immediately cease use of this website. The contents of this website have not been prepared for the benefit of investors outside of the United States. This website is not intended as a solicitation of the purchase or sale of any security or other financial instrument or any investment management services for any investor who resides in a jurisdiction other than the United States1. As a general matter, Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) is not licensed or registered to solicit prospective investors and offer investment advisory services in jurisdictions outside of the United States. The information on this website is not intended to be distributed to, directed at or used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Persons in respect of whom such prohibitions apply must not access the website.  Under certain circumstances, BBH may provide services to investors located outside of the United States in accordance with applicable law. The conditions under which such services may be provided will be analyzed on a case-by-case basis by BBH. BBH will only accept investors from such jurisdictions or countries where it has made a determination that such an arrangement or relationship is permissible under the laws of that jurisdiction or country. The existence of this website is not intended to be a substitute for the type of analysis described above and is not intended as a solicitation of or recommendation to any prospective investor, including those located outside of the United States. Certain BBH products or services may not be available in certain jurisdictions. By choosing to access this website from any location other than the United States, you accept full responsibility for compliance with all local laws. The website contains content that has been obtained from sources that BBH believes to be reliable as of the date presented; however, BBH cannot guarantee the accuracy of such content, assure its completeness, or warrant that such information will not be changed. The content contained herein is current as of the date of issuance and is subject to change without notice. The website’s content does not constitute investment advice and should not be used as the basis for any investment decision. There is no guarantee that any investment objectives, expectations, targets described in this website or the  performance or profitability of any investment will be achieved. You understand that investing in securities and other financial instruments involves risks that may affect the value of the securities and may result in losses, including the potential loss of the principal invested, and you assume and are able to bear all such risks.  In no event shall BBH or any other affiliated party be liable for any direct, incidental, special, consequential, indirect, lost profits, loss of business or data, or punitive damages arising out of your use of this website. By clicking accept, you confirm that you accept  to the above Important Information along with Terms and Conditions.

 
1BBH sponsors UCITS Funds registered in Luxembourg, in certain jurisdictions. For information on those funds, please see bbhluxembourgfunds.com


captcha image

Type in the word seen on the picture

I am a current investor in another jurisdiction