Dollar Soft Ahead of FOMC Meeting

July 25, 2022

U.S. rates are inching higher but continue to price in doom and gloom ahead of the FOMC meeting that begins tomorrow; June Chicago Fed NAI will be watched closely for further signs of recession; regional Fed manufacturing surveys for July will continue rolling out.
ECB officials continue to send mixed messages; Germany remains the weak link in the eurozone; U.K. CBI released the results of its July industrial trends survey
New BOJ board member Takata said the economy still needs policy support; Singapore reported June CPI

The dollar is losing ground as concerns about the U.S. economy build. DXY is down for the third straight day and trading near 106.459. Despite the ECB’s hawkish surprise last week, the euro remains unable to make much headway above $1.02. We believe this is due to mixed ECB comments and weak eurozone data (see below). The weakening trend in the yen remains stalled despite dovish comments from the BOJ (see below), with USD/JPY trading near 136 after trading as high as 138.90 last week. Sterling is testing last week’s high near $1.2065 but will likely face difficulty moving much higher as the data continue to weaken (see below). We are not yet ready to change our strong dollar call. Yes, the U.S. economic data have been weakening but we do not think a recession is imminent. When all is said and done, we believe the U.S. economy remains the most resilient. However, we expect a period of consolidation ahead for the dollar until the U.S. economic outlook becomes clearer.


U.S. rates are inching higher but continue to price in doom and gloom ahead of the FOMC decision. The 10-year yield is trading around 2.80% after ending last week near 2.75% and trading as low as 2.73%, while the 2-year yield is trading near 2.99% after ending last week near 2.97% and trading as low as 2.90%. While we believe some signs of improvement in inflation are emerging, most measures remain elevated and so the Fed is likely to continue tightening policy in H2. Curve flattening has stopped, at least for today. The 2- to 10-year curve has recovered to -19 bp today from the cycle low of -22 bp on Friday. Faithful readers know that we prefer to look at the 3-month to 10-year curve but that too is moving in a worrisome manner. At 42 bp, it has recovered from 37 bp on Friday that was the flattest since March 2020. The speed of flattening has been nothing short of astounding, as it stood at 139 bp at the start of July and was 185 bp in mid-June.

Obviously, all eyes are on the two-day FOMC that begins tomorrow. The Fed remains widely expected to hike rates 75 bp to 2.50%. WIRP suggests only around 10% odds of a 100 bp move. Updated macro forecasts and Dot Plots won’t come until the September meeting. Another 75 bp hike September 21 is only about 45% priced in, with a 50 bp move favored then. A 25 bp hike is priced in for November 2 but after that, one last 25 bp hike is only partially priced in. The swaps market paints a similar picture, with 175 of tightening priced in over the next 6 months that would see the policy rate peak near 3.5%. Then, an easing cycle is priced in for the subsequent 6 months.

June Chicago Fed National Activity Index will be watched closely for further signs of recession. It is expected at -0.03 vs. a revised -0.19 in May. If so, the 3-month moving average would fall to 0.01 vs. a revised 0.09 in May. This would be the lowest since February 2021 but still well above the -0.7 threshold that signals imminent recession. Obviously, the slowdown is concerning and we need to keep an eye on this data series, as well as the U.S. yield curve.

Regional Fed manufacturing surveys for July will continue rolling out. Dallas Fed reports today and is expected at -22.0 vs. -17.7 in June. Richmond reports Tuesday and is expected at -17 vs. -11 in June. Kansas City wraps things up Thursday and is expected at 4 vs. 12 in June. So far, Philly Fed came in at -12.3 vs. -3.3 in June and the Empire survey came in at 11.1 vs. -1.2 in June. Last Friday, preliminary July S&P Global PMI readings for the U.S. came in much weaker than expected as the composite fell to 47.5, the lowest since May 2020 and driven mostly by a drop in services to 47.0. As such, there are clearly downside risks to this week’s survey data.


ECB officials continue to send mixed messages. Visco said “We will see depending on data how to go on, but this does not mean that we are not going to proceed in a gradual way.” On the other hand, Kazaks said the bank may not be done with its larger hikes and that “I would say that the rate increase in September also needs to be quite significant.” WIRP suggests a 50 bp hike is now nearly priced in for the next meeting September 8 and is about 35% priced in for October 27. Looking ahead, the swaps market is now pricing in 175 bp of tightening over the next 24 months that would see the deposit rate peak near 1.75%, with some odds seen of another 25 bp hike thereafter.

Germany remains the weak link in the eurozone. IFO business climate survey for July was reported. Headline came in at 88.6 vs. 90.1 expected and a revised 92.2 (was 92.3) in June, with current assessment falling to 97.7 vs. a revised 99.4 (was 99.3) in June and expectations falling to 80.3 vs. a revised 85.5 (as 85.8) in June. IFO President Clemens Fuest said “Germany is on the brink of a recession. High energy prices and the threat of gas shortages are weighing on the economy. Companies are expecting significantly worse business activity in the coming months.” GfK consumer confidence for August will be reported Wednesday and is expected at -28.9 vs. -27.4 in July. Recall that preliminary July PMI readings last week showed Germany tipping into recession; this week’s readings simply confirm this.

U.K. CBI released the results of its July industrial trends survey. Total orders came in at 8 vs. 13 expected and 18 in June, selling prices came in at 48 vs. 55 expected and 58 in June, and business optimism came in at -21 vs.-34 in June. Orders were the lowest since April 2021, while selling prices were the lowest since September 2021. Distributive trades survey will be reported Tuesday, with retailing reported sales expected at -10 vs. -5 in June. Bank of England expectations remain subdued. WIRP suggests a 50 bp hike move at the August 4 meeting is only around 80% priced in; at the start of last week, it was fully priced in. Similarly, 50 bp hikes are no longer fully priced in for the subsequent meetings September 15 and November 3, while a 25 bp hike December 15 remains fully priced in. Looking ahead, the swaps market is pricing in 150-175 bp of tightening over the next 6 months that would see the policy rate peak between 2.75-3.0%.


New Bank of Japan board member Hajime Takata said the economy still needs policy support. He added that the current Yield Curve Control framework is sustainable. Takata replaces Goushi Kataoka, who many consider one of the most dovish board members. Takata is also one of two board members chosen so far by Prime Minister Kishida. Of course, the most important one will be his choice to replace Governor Kuroda, whose second term ends next spring. We continue to believe that current policy will be maintained through the end of Kuroda’s term. Indeed, recent Japan data will be seen as vindication by the BOJ in terms of its loose policy stance; the economy remains sluggish but inflation remains under control. The swaps market is basically pricing in steady policy for the next 36 months, with very small odds of liftoff seen towards the end of that period.

Singapore reported June CPI. Headline came in at 6.7% y/y vs. 6.2% expected and 5.6% in May, while core came in at 4.4% y/y vs. 4.1% expected and 3.6% in May. Headline was the highest since September 2008. While the MAS does not have an explicit inflation target, rising price pressures led to intra-meeting tightening this month and it will likely tighten again at its next scheduled meeting in October.

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