Dollar Remains Soft Ahead of CPI Data

August 10, 2022

Win Thin

Fed speakers will continue spreading the hawkish message; Fed tightening expectations continue to adjust; July CPI will be the highlight; the heavy slate of Treasury issuance this week continues
The U.K. energy outlook continues to deteriorate; despite the gloomy macro outlook, the BOE is set to continue tightening as inflation spirals ever higher; Norway reported July CPI
Japan reported July PPI; China reported July CPI and PPI; Thailand hiked rates 25 bp to 0.75%, as expected

The dollar is softer ahead of the CPI data. DXY is down for the third straight day and is trading near 106.1 currently. The euro is trading above $1.02 but remains heavy. Similarly, sterling remain heavy and is trading back below $1.21 as the fundamental outlook worsens (see below). USD/JPY remains stuck near 135 but the rally should resume as recent softness in the data should underscore the need to keep BOJ policy ultra-loose. Thailand become the latest in EM to start a tightening cycle (see below). We maintain our strong dollar call but profess disappointment that it has not been able to move much higher after last week’s perfect mix of hawkish Fed officials and strong U.S. data.

AMERICAS

Fed speakers will continue spreading the hawkish message. Evans and Kashkari speak today. What we saw last week was a master class in central bank communication, and that has carried over into the weekend and this week. The Fed was unhappy with the market’s interpretation of the July FOMC decision and went all out in a unified and credible manner to convey this. We expect this communication effort to continue for the foreseeable future.

Fed tightening expectations continue to adjust. WIRP now showing over 75% odds of a 75 bp hike at the September 20-21 FOMC meeting. Looking ahead, the swaps market is now pricing in a 3.75% terminal rate vs. 3.5% at the start of last week. We think this is the correct read right now and if the market gives the Fed 75 bp next month, the Fed will take it. Market is still pricing in a quick turnaround by the Fed into an easing cycle in H1 2023. It's pretty clear that the Fed doesn't see it that way and the data bear that out, at least for now. Market should also reprice these easing expectations in the coming days and weeks.

July CPI will be the highlight. Headline is expected at 8.7% y/y vs. 9.1% in June, while core is expected at 6.1% y/y vs. 5.9% in June. If so, it would of course be mixed news but the drop in headline would be welcome news. PPI will be reported tomorrow. Headline is expected at 10.4% y/y vs. 11.3% in June, while core is expected at 7.7% y/y vs. 8.2% in June. While some inflation measures are showing signs of turning lower, it is way too early for the Fed to declare victory and so for now, it’s full speed ahead in terms of tightening. June wholesale inventories, trade sales, and July budget will be reported.

The heavy slate of Treasury issuance this week continues. Yesterday’s $42 bln sale of 3-year notes went very well, with indirect bidders taking 63.1% vs. 60.4% previously and the bid/cover ratio at 2.50 vs. 2.43 previously. Today, Treasury will sell $35 bln of 10-year notes. At the previous 10-year auction, indirect bidders took 61.3% and the bid/cover ratio was 2.34. Tomorrow, Treasury will sell $21 bln of 30-year bonds. At the previous 30-year auction, indirect bidders took 73.2% and the bid/cover ratio was 2.44.

EUROPE/MIDDLE EAST/AFRICA

The U.K. energy outlook continues to deteriorate. Reports suggest Chancellor Zahawi and Business Secretary Kwarteng will hold crisis talks with U.K. energy companies after another huge boost to the household energy cap in January is coming into view. One energy analyst is forecasting household energy bills will rise to around GBP3,600 in October vs. GBP1,971 currently before rising further to over GBP4,200 in January. The cap was first introduced in January 2019 at around GBP1,050 but has been increased several times already, the latest coming in April. Press reports suggest that energy companies will be asked to submit their breakdowns of expected profits and payouts as well as investment plans for the next three years.

Despite the gloomy macro outlook, the BOE is set to continue tightening as inflation spirals ever higher. WIRP suggests a 25 bp hike September 15 is fully priced in, with 85% odds of a larger 50 bp move. The swaps market is pricing in 125-150 bp of tightening over the next 6 months that would see the policy rate peak between 3.0-3.25%, up from 2.75% at the start of last week.

Norway reported July CPI. Headline came in at 6.8% y/y vs. 6.3% expected and actual in June, while underlying came in at 4.5% y/y vs. 3.8% expected and 3.6% in June. At the last policy meeting June 23, Norges bank hiked 50 bp to 1.25% vs. 25 bp expected. It warned that “In the Committee’s assessment, a markedly higher policy rate is needed to stabilize inflation around the target.” It also flagged a likely 25 bp hike to 1.5% at the next meeting August 18, but today’s CPI data raises the odds of another 50 bp move. Of note, the updated June rate path suggested a steeper tightening cycle ahead as the bank now sees the policy rate peaking near 3.1% in 2024 vs. 2.5% previously. This is more aggressive than the market, as the swaps market is pricing in 100 bp of tightening over the next 12 months that would see the policy rate peak near 2.25%. We believe market pricing will eventually move closer to the Norges Bank’s expected path.

ASIA

Japan reported July PPI. It came in at 8.6% y/y vs. 8.4% expected and a revised 9.4% (was 9.2%) in June. Even though it was slightly higher than expected, it continues the deceleration trend from the 10.0% peak in April and suggests that price pressures may be topping out. In turn, this supports the Bank of Japan’s decision to maintain its ultra-dovish stance for the time being. Next policy meeting is September 21-22 and no change is expected then.

China reported July CPI and PPI. CPI came in at 2.7% y/y vs. 2.9% expected and 2.5% in June, while PPI came in at 4.2% y/y vs. 4.9% expected and 6.1% in June. CPI inflation was the highest since July 2020 and nearing the 3% target, driven largely by higher pork prices. The PPI reading was the lowest since February 2021 and has fallen every month since the 13.5% y/y peak in October 2021, which suggests CPI readings should come down in the coming months. As it is, the focus for policymakers is clearly on boosting growth even as this year’s target of “around 5.5%” will be impossible to meet.

Bank of Thailand hiked rates 25 bp to 0.75%, as expected. The vote was 6-1 vs. 4-3 to hold rates at the last meeting June 8, so three MPC members shifted their position. However the pace of tightening is likely to be cautious as the bank noted “The committee views that the policy rate should be normalized to the level that is consistent with sustainable growth in the long term. Monetary policy normalization should be done in a gradual and measured manner consistent with the growth and inflation outlook in the period ahead.” Assistant Governor Piti added “Too big an increase may raise bad debts and put pressure on banks. There is no need to rush.” The swaps market is pricing in 150 bp of tightening over the next 36 months that would see the policy rate peak near 2.25%.

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