• Fed tightening expectations continue to adjust; Chicago Fed National Activity Index for July will be the highlight
  
• Bundesbank offered a worrisome outlook for Germany; ECB tightening expectations remain elevated; Israel is expected to hike rates 50 bp to 1.75%
  
• RBNZ hinted that rates may go slightly higher than forecast; China’s commercial banks cut their loan rates; trade data out of Asia were weak
  

The dollar continues to gain as the new week begins. DXY is up for the fourth straight day and is coming off of its best week since March 2020, trading near 108.17 currently. This is the highest since July 15 and it is on track to test the July 14 high near 109.294. The euro remains heavy and is currently trading near parity as the fundamental outlook for the eurozone deteriorates. The single currency is on track to test the July 14 cycle low near $0.9950. After that is the September 2002 low near $0.9615. Sterling is also making new lows for this move near $1.1780 and is on track to test the July 14 low near $1.1760. After that is the March 2020 low near $1.1410. USD/JPY is edging higher and trading just below 137, and 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, the dollar should continue to benefit from the relatively strong U.S. economic outlook and heightened Fed tightening expectations. These drivers are likely to persist this week, with Fed Chair Powell expected to deliver a hawkish message at Jackson Hole and eurozone PMIs expected to show further softness in August.

AMERICAS

Fed tightening expectations continue to adjust. WIRP suggests a 50 bp hike is fully priced in for the September 20-21 FOMC meeting, with nearly 65% 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 move higher, with the 2-year yield trading near 3.29% currently after ending last week near 3.23% and the 10-year trading near 2.98% currently after ending last week near 2.97%.

Chicago Fed National Activity Index for July will be the highlight. With recession fears rising, CFNAI should be closely watched. It is expected at -0.25 vs. -0.19 in June. If so, the 3-month moving average would fall to -0.21 vs. -0.04 in June and would be the lowest since June 2020. The negative reading would suggest growth is below trend but that is what the Fed wants right now. It would also still be well above the -0.7 threshold that signals imminent recession. However, many still fear a hard landing and so we need to keep an eye on this data series as well as the U.S. yield curve. At 35 bp, the 3-month to 10-year curve is the highest since August 21 and off the low near 21 bp. While this move higher is welcome, the risks of eventual inversion remain high.

EUROPE/MIDDLE EAST/AFRICA

The Bundesbank offered a worrisome outlook for Germany. In its monthly report, the bank warned that the continued loss of purchasing power as well as a tight labor market will likely result in greater upward pressure on wages compared with Q2. It noted that inflation should reach about 10% in the fall as several government measures expire, adding that the higher minimum wage and the weaker euro are causing price pressures. As such, the Bundesbank noted that continued normalization of ECB policy is appropriate since inflation risks skewed to the upside. Lastly, the bank warned that the odds of economic contraction this winter have risen significantly due to the outlook for natural gas.

ECB tightening expectations remain elevated. WIRP suggests a 50 bp hike is fully priced in for September 8, with 20% odds seen of a larger 75 bp move. The swaps market is pricing in 175 bp of tightening over the next 12 months that would see the deposit rate peak near 1.75%, up from 1.5% at the start of last week. Yet higher expected rates have done nothing for the euro. The single currency traded below parity today to the lowest level since July 14 and is on track to test that day’s low near $0.9950. After that, the next target is the September 2002 low near $0.9615.

Bank of Israel is expected to hike rates 50 bp to 1.75%. At the last meeting July 4, the central bank hiked rates 50 bp to 1.25% July 4, the first 50 bp hike since 2011. The bank noted that “The Israeli economy is recording strong growth, accompanied by a tight labor market and an increase in the inflation environment.” It also stopped referring to the tightening cycle “gradual” and sees the policy rate at 2.75% in Q2 2023. Since then, inflation accelerated to 5.2% y/y in July vs. 4.6% expected and 4.4% in June, the highest since October 2008 and further above the 1-3% target range. The swaps market is pricing in only 100 bp of tightening over the next 6 months that would see the policy rate peak near 2.25% but this seems too low. Ahead of the decision, Israel reports July unemployment and June manufacturing production.

ASIA

The RBNZ hinted that rates may go slightly higher than forecast. Deputy Governor Hawkesby noted that the bank’s most recent forecasts show the policy rate peaking at 4.1% in mid-2023, which he said means there’s a risk of it climbing to 4.25%. He said “We’re deliberately ambiguous to reflect that uncertainty of where the end point may be. It could be 4%, it could be 4.25%, it could be a balanced range around that.” Hawkesby added that the bank hasn’t settled on a new estimate for the neutral rate but “we’ve talked about a range of 2-3%” and stressed that “In an environment where we do have strong domestic inflation pressures that we are looking to lean in against you need to be shifting the Official Cash Rate into that zone where you can be more comfortable that you’re doing your work of leaning in.” Lastly, Hawkesby acknowledged that the RBNZ is getting closer to the point where it may slow the pace of tightening, noting “I think it’s definitely on the horizon. It’s that idea that as we get closer to the peak of what we’re projecting, as we get closer to being comfortably above neutral, then our decisions become more finely balanced.” WIRP suggests a 50 bp hike at the next meeting October 5 is nearly 85% priced in, while the swaps market is pricing in 100 bp of tightening over the next 6 months that would see the policy rate peak near 4.0%.

China’s commercial banks cut their loan rates. After the PBOC surprised markets with a 10 bp cut in its key 1-year MLF rate last week, banks were expected to cut their 1- and 5-year Loan Prime Rates by the same magnitude to 3.60% and 4.35%, respectively. Instead, they were cut to 3.65% and 4.30%, with the bigger cut at the long end meant to support the housing market. Yet these moves are still largely symbolic. By most accounts, the demand for loans has slowed sharply due to weakness in the property sector and so the rate cuts are akin to pushing on a string. If the economy continues to slow, we expect fiscal stimulus to pick up the slack. August PMI readings out next week should give a better read of just how much the economy is slowing.

Trade data out of Asia were weak. Taiwan July export orders came in at -1.9% y/y vs. 6.2% expected and 9.5% in June. This was the weakest since April and points to further weakness ahead in shipments. Elsewhere, Korea reported weak trade data for the first 20 days of August. Exports rose 3.9% y/y and imports rose 22.1% y/y. However, the number of working days had an impact as average daily exports rose only 0.5% y/y. Of note, exports to the U.S. rose 0.8% y/y while exports to China fell -11.2% y/y. The regional economies are clearly slowing under the weight of slower mainland growth and tighter monetary policy. KRW is the worst performing currency in emerging Asia at -11.3% YTD, while Taiwan is the third worst at -8.1% YTD. In between is PHP at -9.3% YTD.