Dollar Soft After CPI and BOJ Surprises

July 12, 2024

Win Thin

Dollar weakness seems overdone; June CPI data was encouraging; another month of good inflation data still won’t get the Fed to cut this month; June PPI and University of Michigan preliminary July consumer sentiment will be reported
ECB is now in the quiet period ahead of next Thursday’s decision; Sweden reported soft June CPI data
BOJ intervened during the North American session after the CPI data; China reported soft June money and new loan data; China also reported June trade; India reports June CPI and May IP

The dollar is trading soft in the wake of CPI and BOJ intervention. DXY is trading lower for the third straight day near 104.340 as markets digest the double whammy of good inflation data and surprise BOJ intervention (see below). The BOJ did not get much bang for the buck as USD/JPY has already recouped nearly half of yesterday’s losses and trading back above 159. The euro is trading higher near $1.0890, while sterling is trading higher near $1.2955. SEK is the worst performing major after soft CPI has led markets to start pricing in a fourth cut this year (see below). Recent softness in the U.S. data is challenging our view that the backdrop of persistent inflation and robust growth in the U.S. remains largely in place. Indeed, more Fed officials are voicing concern about labor market weakness. However, we continue to believe that weaker data in many of the major economies will feed into more dovish central banks, underscoring that the relative story should continue to support the dollar.

AMERICAS

Dollar weakness seems overdone. Yes, we got CPI readings that were basically a tick lower than expected, which likely cemented a September cut that was already around 80% priced in. More importantly, the market is pricing in an additional 25 bp of easing over the next 12 months, which we view as an overreaction. Inflation is slowly cooling even as the overall economy remains robust and far from recession. Why would the Fed cut so aggressively? This mispricing has taken a toll on the dollar, but we note that easing expectations for the ECB and BOE have also picked up in the wake of the CPI data. As such, we believe the relative story hasn’t changed enough to warrant continued dollar weakness.

It didn’t help that the BOJ intervened right after the CPI data, further muddying the waters. This likely added to the broad dollar weakness but as we saw after the April and May BOJ interventions, USD/JPY recovered to make new highs. We expect a similar dynamic to unfold in the coming days and weeks. See below for a more in-depth discussion of BOJ intervention.

June CPI data was encouraging. Headline came in a tick lower than expected at 3.0% y/y vs. 3.3% expected, while core came in a tick lower than expected at 3.3% y/y vs. 3.4% in May. Super core slowed a tick for the straight second month to 4.7% y/y. Of note, the Cleveland Fed’s Nowcast model is now tracking July headline at 3.0% and core at 3.3%.

Another month of good inflation data still won’t get the Fed to cut this month. Indeed, Musalem said “CPI inflation for June points to encouraging further progress towards lower inflation. I will be looking for more evidence that inflation can be expected to converge to 2% going forward.” That doesn’t sound like someone that wants to ease this month. After the July 30-31 meeting, the Fed will see July and August readings for jobs, CPI, PPI, and retail sales and the July PCE reading ahead of the September 17-18 FOMC meeting. By that point, the Fed should have a much better idea of where the economy is going and will feel more comfortable making a policy pivot. The market is pricing in less than 10% odds of a cut this month but is fully priced in for September.

June PPI will be reported today. Headline is expected to rise a tick to 2.3% y/y while core is expected to rise two ticks to 2.5% y/y. Watch out for PPI ex-trade, transportation, and warehousing as it feeds into the core PCE calculations. This measure rose 4.5% y/y in May and another sticky print well above 4% y/y would be an upside risk to the PCE data.

University of Michigan preliminary July consumer sentiment will also be reported. Headline is expected at 68.5 vs. 68.2 in June. This would be consistent with softer household spending activity. 1-year inflation expectations are expected to fall a tick to 2.9%, while 5- to 10-year expectations are expected to remain steady at 3.0%. Sticky inflation expectations should also keep the Fed cautious.

The economy is still holding up relatively well. The New York Fed Nowcast model is tracking Q2 growth at 1.8% SAAR and Q3 at 2.1% SAAR and will be updated later today. Elsewhere, the Atlanta Fed GDPNow model now tracking Q2 growth at 2.0% SAAR vs. 1.5% previously. Next update will be next Tuesday after the data. Bottom line: despite cooling in some areas, the economy remains relatively robust. That should give the Fed confidence to stay on hold in July, but with an eye towards cutting rates in September.

EUROPE/MIDDLE EAST/AFRICA

ECB is now in the quiet period ahead of next Thursday’s decision. No change is expected then, but the market is pricing in 85% odds of a cut September 12. Similar odds are seen for a cut December 12. The market is currently pricing in a Fed that's more dovish over the next 12 months (125 bp of easing) than both the ECB and BOE (100 bp). Given how strong the US economy is compared to the eurozone and UK, we believe this is serious mispricing and when it's unwound it could eventually help the dollar gain more traction.

Sweden reported soft June CPI data. Headline came in 2.6% y/y vs. 2.8% expected and 3.7% in May, CPIF came in at 1.3% y/y vs. 1.6% expected and 2.3% in May, and CPIF ex-energy came in at 2.3% y/y vs. 2.5% expected and 3.0% in May. CPIF is the lowest since December 2020 and is now below the 2% target. No wonder the Riksbank tilted even more dovish last month as it shifted its forward guidance to “the policy rate can be cut two or three times during the second half of the year.” A 25 bp cut at the next meeting August 20 is more than fully priced in. Looking ahead, three cuts are fully priced in by year-end, with nearly 30% odds of a fourth cut. SEK is likely to continue underperforming NOK.

ASIA

The Bank of Japan intervened during the North American session after the CPI data. We are very surprised they intervened given that USD/JPY only moved 4 big figures and then quickly recovered. In the past few interventions, the pair has moved 5-6 big figures and did not bounce back so quickly. Of note, Vice Minister for international affairs Kanda played it coyly, saying he was not in a position to say whether there was indeed intervention. Officials will try to keep the market guessing. Reports suggest the Bank of Japan conducted so-called rate checks with traders during the Asian morning hours.

The monthly MOF data on BOJ intervention for July won't be out until early August. Early estimates based on BOJ accounts suggest it spent around JPY3.5 trln yesterday. Last time they intervened in late April/early May (picked up in the May data), the total was JPY9.8 trln, which was close to what was spent total back in both September and October 2022. As the previous round of JPY9.8 trln did nothing to reverse the trend higher in USD/JPY, we can only assume this smaller round won’t succeed either. Rather, a more hawkish BOJ or more dovish Fed is needed.

China reported June money and new loan data. New loans came in at CNY2.1 trln vs. CNY2.3 trln expected and CNY945 bln in May, while aggregate financing came in at CNY3.3 trln vs. CNY3.42 trln expected and CCNY2.065 trln in May. More importantly, the y/y rates for new loans and M2 continue to fall and are unlikely to turn around anytime soon given the lack of significant monetary stimulus in the pipeline.

China also reported June trade. Exports came in at 8.6% y/y vs. 8.0% expected and 7.6% in May, while imports came in at -2.3% y/y vs. 2.5% expected and 1.8% in May. This led to a record monthly surplus of $99.05 bln and will do little to ease tensions with its trading partners. The drop in imports was the first since March and supports our view that domestic activity continues to struggle under the weight of the massive debt overhang.

India reports June CPI and May IP. Headline inflation is expected at 4.80% y/y vs. 4.75% in May, while IP is expected to fall a tick to 4.9% y/y. At the last meeting June 7, the Reserve Bank of India kept rates steady at 6.5% but the voting split suggests the bar to ease policy is falling. The vote was 4-2 to keep rates on hold versus 5-1 in April. Goyal joined Varma in voting for a 25 bp cut. The market is pricing in steady rates over the next six months followed by the possible start of an easing cycle over the subsequent six months as inflation falls towards the mid-point of the RBI’s 2-6% target range.

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