Dollar Soft Ahead of CPI Data

July 11, 2024
  • Powell stayed on message; labor market weakness appears to be a growing Fed concern; June inflation data take center stage; Peru is expected to keep rates steady at 5.75%; Banco de Mexico releases its minutes
  • The monthly U.K. data dump began; some BOE officials remain cautious
  • Japan reported May core machine orders; Korea delivered a dovish hold; Malaysia kept rates steady at 3.0%, as expected

The dollar is trading soft ahead of CPI data. DXY is trading lower for the second straight day near 104.842 as markets await key inflation data (see below). The euro is trading higher near $1.0850, and sterling is trading higher near $1.2880 after stronger than expected data (see below). USD/JPY is trading lower near 161.55. 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 (see below). However, this week’s developments highlight the fact 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. Today’s CPI data will be key in setting near-term Fed expectations.

AMERICAS

Fed Chair Powell stayed on message in his testimony before the House Financial Services Committee. Powell said the Fed’s job is not yet done on inflation and that it has more work to do. He said that he’s not prepared to say that inflation confidence is sufficient yet to cut rates. However, Powell stressed the Fed doesn’t need inflation below 2% before cutting rates but then admitted that there’s no particular inflation number in mind for cuts to begin. This was the same cautious tone as he took before the Senate Tuesday.

However, labor market weakness appears to be a growing Fed concern. Powell admitted that the number one thing keeping him up at night is the inflation-labor balance. This echoes concerns expressed last week by Goolsbee and Daly about a weaker labor market, as well as comments from Cook late yesterday. While she said the data so far seem consistent with a soft landing, Cook stressed that the Fed is “very attentive” to higher unemployment and would be “responsive” if it worsened. The recent shift in tone is worth noting but Fed expectations are little changed this week. The market is pricing in less than 5% odds of a cut this month and around 75% in September, both slightly lower than pre-NFP. Bostic and Musalem speak today.

June inflation data take center stage. CPI will be reported today. Headline is expected to fall two ticks to 3.1% y/y while core is expected to remain steady at 3.4% y/y. Keep an eye on super core, which slowed a tick to 4.8% y/y in May. Of note, the Cleveland Fed’s Nowcast model is tracking headline at 3.1% and core at 3.5%. Looking ahead, the model is tracking July headline at 3.2% and core at 3.6%.

Even another month of improved inflation data won’t get the Fed to cut 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 an explicit policy pivot.

The economy is still holding up relatively well. 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. Elsewhere, the New York Fed Nowcast model is tracking Q2 growth at 1.8% SAAR and Q3 at 2.1% SAAR and will be updated this Friday. 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.

Peru central bank is expected to keep rates steady at 5.75%. However, a couple of analysts look for a 25 bp cut to 5.5%. At the last meeting June 13, the bank delivered a hawkish surprise and kept rates steady at 5.75% vs. an expected 25 bp cut. The bank justified standing pat then by noting that “core inflation shows some persistence derived from some service components.” Core inflation rose to an 8-month high at 3.12% y/y in June from 3.10% in May and so it seems likely that the rate pause will be extended today.

Banco de Mexico releases its minutes. At the June 27 meeting, the bank kept rates steady at 11.0% by a 4-1 vote, with the dissent in favor of a 25 bp cut. At the previous meeting May 9, the vote to hold rates was unanimous and so the door to a rate cut is slowly opening. Afterwards, Governor Rodriguez said rates cuts will be “on the table” in the next meetings and added “Going forward, what we’re seeing is that we’ll have space to reduce the degree of restriction. Reducing the rate does not mean that we will stop being restrictive.” Next meeting is August and with inflation still accelerating, no change is expected then. However, the market is pricing in 25 bp of easing over the next three months and a total of 100 bp over the next twelve months.

EUROPE/MIDDLE EAST/AFRICA

The monthly U.K. data dump began. May GDP, IP, services, and construction output were reported. GDP came in two ticks higher than expected at 0.4% m/m vs. flat in April, IP came in a tick lower than expected at 0.2% m/m vs. -0.9% in April, services came in a tick higher than expected at 0.3% m/m vs. a revised 0.3% (was 0.2%) in April, and construction came in at 1.9% m/m vs. 0.7% expected and a revised -1.1% (was -1.4%) in April. The y/y rates generally improved from April.

Some Bank of England officials remain cautious. Chief Economist Pill said rate cuts were a matter of “when, not if.” However, he warned that inflation remains persistent, with some indications of upside risks. Pill noted that the MPC is watching this persistence and added that the question is whether to let this persistence play out or now. Lastly, he said it’s still an open question whether the time to cut is now. Elsewhere, Mann said “The 2% that we have seen is a touch and go, meaning we’re going to be above 2% for the rest of the year and that matters for my decision making.” She added “We still see labor market tightness as revealed wage growth, that still remains well away from target consistent wage growth.” We still believe that the BOE will cut rates sooner rather than later. The market sees around 50% odds of a cut August 1, but we believe that there is simply no reason to wait until September 19 when inflation has already fallen to the 2% target.

ASIA

Japan reported May core machine orders. Orders came in at 10.8% y/y vs. 7.1% expected and 0.7% in April. This was the strongest since July 2022 but was due in large part to low base effects. Indeed, orders fell -3.2% m/m vs. -2.9% in April. Earlier this week, June machine tool orders came in at 9.7% y/y vs. 4.2% in May. Much of the recent economic data have come in soft and is likely to keep the Bank of Japan in cautious mode.

Bank of Korea delivered a dovish hold. It kept rates steady at 3.5%, as expected, but said that it will consider rate cut timing while assessing the outlook for inflation and financial stability. The decision was unanimous, but Governor Rhee said that excluding him, four BOK members saw steady rates over the next three months and two were open to a rate cut during that same period. Rhee also noted that “Market expectations for a cut are somewhat excessive.” The next meeting is August 22 and seems too soon for a cut. Indeed, the market still sees steady rates over the next three months, followed by 25 bp of easing over the subsequent three months.

Bank Negara Malaysia kept rates steady at 3.0%, as expected. It noted that “As expected, inflation will trend higher in the second half of 2024, amid the recent rationalization of diesel subsidies,” adding that while it views the impact as manageable, upside risks will depend on “spillover effects of further domestic policy measures on subsidies and price controls to broader price trends.” Of note, June CPI data out July 24 should reflect higher diesel fuel prices resulting from the subsidy cuts. Next meeting is September 5, and no change is expected then. The market continues to price in steady rates over the next three years.  

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