• The Fed released its Beige Book report; meanwhile, Fed officials remain hawkish; BOC hiked rates 75 bp to 3.25%, as expected; Peru is expected to hike rates 50 bp to 7.0%
  
• The ECB is expected to hike rates 75 bp; Prime Minister Truss is expected to unveil her plan to help the U.K. cope with higher energy costs; BOE testimony to Parliament’s Treasury Committee was tepid
  
• Japan reported firmer final Q2 GDP data; July current account data are worth discussing; Australia reported July trade data; New Zealand reported Q2 manufacturing activity; Malaysia hiked rates 25 bp to 2.50%, as expected
  

The dollar is soft ahead of the ECB decision. After trading at a new cycle high yesterday near 110.786, DXY reversed lower and is currently trading near 109.59. The euro led the recovery in the foreign currencies and is currently trading just above $1.00. We think it's dangerous to go into today's ECB decision long euros as we feel the risks are skewed (as always with the ECB) towards disappointment. We'll know more shortly. Sterling also bounced yesterday after testing the March 2020 low near $1.1410 and is currently trading just above $1.15. We look for an eventual break below that low and target the December 1985 all-time low near $1.0520. USD/JPY traded at a new high for this move near 145 yesterday but is currently trade back below 144. We maintain our target of 147.65, the August 1998 high. Indeed, we maintain our strong dollar call as it benefits from both a solid U.S. economic outlook and growing risk-off impulses from Europe.

AMERICAS

The Fed released its Beige Book report. On overall economic activity: “Economic activity was unchanged, on balance, since early July, with five Districts reporting slight to modest growth in activity and five others reporting slight to modest softening. The outlook for future economic growth remained generally weak, with contacts noting expectations for further softening of demand over the next six to twelve months.” On labor markets: “Employment rose at a modest to moderate pace in most Districts. Overall labor market conditions remained tight, although nearly all Districts highlighted some improvement in labor availability, particularly among manufacturing, construction, and financial services contacts. Looking ahead, employers planned to provide end-of-year pay raises to their workers, but expectations for the pace of wage growth varied across industries and Districts.” On prices: “Price levels remained highly elevated, but nine Districts reported some degree of moderation in their rate of increase. Most contacts expected price pressures to persist at least through the end of the year.” We think this current backdrop will give the Fed cover to hike another 75 bp at the September 20-21 FOMC meeting.

Meanwhile, Fed officials remain hawkish. Powell speaks today for the first time since Jackson Hole and we can expect a repeat performance of his hawkish tone. Yesterday, Vice Chair Brainard said the Fed needs to see “several months” of low inflation to be convinced that it was finally cooling and added “We are in this for as long as it takes to get inflation down.” Mester said the Fed’s aim is not to create a recession but added that she needs to see compelling evidence that inflation is falling and that “I’m not convinced that inflation has peaked yet.” She still backs hiking rates above 4% by early 2023 and keeping them there. Mester would not say what move she favors at the September FOMC meeting and noted that her focus is on the path of rates, not the size of the hike at the next meeting. Lastly, Vice Chair Barr said inflation is “far too high” and said he’s committed to bringing it down. However, he declined to say how high rates should go.

Bank of Canada hiked rates 75 bp to 3.25%, as expected. For now, this leaves Canada with the highest policy rate in the majors, edging out New Zealand with 3.0%. The bank warned that “Given the outlook for inflation, governing council still judges that the policy interest rate will need to rise further” but dropped the reference to front-loading the rate hikes and added “As the effects of tighter monetary policy work through the economy, we will be assessing how much higher interest rates need to go to return inflation to target.” WIRP suggests nearly 75% odds of a 50 bp hike at the next meeting October 26. Senior Deputy Governor Rogers will hold a press conference today and will likely give more insight to the bank’s decision.

Peru central bank is expected to hike rates 50 bp to 7.0%. August inflation came in at 8.40% y/y vs. 8.74% in July. This was the second straight month of deceleration but inflation remains well above the 1-3% target range.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank is expected to hike rates 75 bp. WIRP suggests nearly 75% odds of a 75 bp hike but with the hawks in control, the ECB will very likely take the plunge. Higher than expected August CPI readings certainly make the case for more aggressive tightening and it seems more and more on the Governing Council are leaning towards this outcome. While the energy crisis adds another wrinkle to the process, we think it is too early yet for it to impact ECB policy right now. New macro forecasts will be released today. As always, Madame Lagarde’s press conference will be important. We can also expect the usual unnamed leaks after the decision. The swaps market is pricing in 25 bp of tightening over the next 12 months that would see the deposit rate peak near 2.25%.

Prime Minister Truss is expected to unveil her plan to help the U.K. cope with higher energy costs. Some details have already been leaked that point to price caps for both households and businesses, with the government absorbing much of the costs of doing so. What hasn’t been revealed is how the government plans to finance this extra spending, which some estimate to be as much as GBP200 bln. Since Truss has ruled out raising taxes, markets are braced for an announcement of greater gilt issuance. Coming at a time when the BOE is starting Quantitative Tightening and raising rates, the increased issuance would only add to the upward pressure on gilt yields.

Bank of England testimony to Parliament’s Treasury Committee was tepid. Of note, we believe markets focused on Chief Economist Pill's comments that suggest the proposed energy caps may lessen the need to hike rates so much. We hesitate to call this dovish but would simply point out that the tone of the BOE testimony is pretty weak sauce compared to Powell's Jackson Hole speech. Tightening expectations fell a bit as a result, as WIRP suggests 55% odds of a 75 bp hike September 15 vs. 70% at the start of the week. Looking ahead the swaps market is pricing in 250 bp of tightening over the next 12 months that would see the policy rate peak near 4.25%, down from 4.5% at the start of this week.

ASIA

Japan reported firmer final Q2 GDP data. Growth was revised up to 0.9% q/q vs. 0.7% expected and 0.5% preliminary. The improvement was driven mostly by upward revisions to business spending, with a slight assist from stronger private consumption and net exports. Inventories also subtracted less from growth. Still, the Q3 data have been decidedly mixed and so we believe the Bank of Japan will keep policy steady at the September 21-22 meeting. If so, policymakers will have to brace for further yen weakness. With our 147.65 target coming into view, we have to start looking beyond that level to the June 1990 high near 160.20. These levels seem pretty crazy as we type them out but until the BOJ pivots, there's not much to support the yen in this current environment. FX intervention with no change in the underlying monetary policy stance would be doomed to failure and so we downplay risks of BOJ intervention for now.

July current account data are worth discussing. The adjusted balance came in at -JPY629 bln vs. JPY65 bln expected and JPY838 bln in June. The external accounts continue to worsen due to higher energy prices and weaker exports. However, the investment flows will be of most interest. July data showed that Japan investors were net sellers of U.S. bonds for the ninth straight month (-JPY1.04 trln). Japan investors turned net sellers (-JPY290 bln) of Australian bonds again and Canadian bonds (-JPY308 bln) for the sixth straight month. Lastly, they turned small net buyers of Italian bonds (JPY29 bln).

Australia reported July trade data. Exports plunged -10% m/m vs. -8% expected and 5% in June, while imports rose 5% m/m vs. flat expected and 1% in June. Exports of iron ore fell -20% m/m, the largest monthly drop since October 2021 and clearly reflects slowing mainland growth. In y/y terms, exports continue to slow while imports continue to rise due to still-strong domestic demand. Of note, RBA Governor Lowe said “We recognize that, all else equal, the case for a slower pace of increase in interest rates becomes stronger as the level of the cash rate rises.” WIRP suggests only 10% odds of a 50 bp hike October 4, while the swaps market is pricing in 140 bp of tightening over the next 12 months that would see the policy rate peak near 3.75%, down from 4.0% at the start of this week.

New Zealand reported Q2 manufacturing activity. Volume fell -4.5% q/q vs. a revised -3.4% (was -3.5%) in Q1. This reading adds to the weaker economic outlook after Q2 real retail sales unexpectedly fell -2.3% q/q vs. -0.9% in Q1, raising the risk that Q2 GDP also contracts again after -0.2% q/q in Q1. GDP reported September 15. WIRP suggests a 50 bp hike to 3.5% October 5 is nearly fully priced in, while the swaps market is pricing in 100-125 bp of tightening over the next 6 months that would see the policy rate peak between 4.0-4.25%, down from 4.5% at the start of this week.

Bank Negara Malaysia hiked rates 25 bp to 2.50%, as expected. The bank noted that “The economy is stronger. It doesn’t need large support like it did during the pandemic.” It said policy is “not on any pre-set course” and added that “Any adjustments to the monetary policy settings going forward would be done in a measured and gradual manner, ensuring that monetary policy remains accommodative.” July CPI was just reported last week at 4.4% y/y, the highest since May 2021. While the bank does not have an explicit inflation target, rising price pressures should keep the tightening cycle going for now. Next policy meeting is November 3 and another 25 bp hike seems likely. The swaps market is pricing in 125 bp of tightening over the next 12 months that would see the policy rate peak near 3.75%, up from 3.25% at the start of this week.