Dollar Soft as China Stimulus Boosts Risk Sentiment Ahead of Jackson Hole

August 25, 2022

Win Thin

The Jackson Hole Economic Symposium begins today; Fed tightening expectations continue to drift higher; regional Fed manufacturing surveys for August will continue rolling out; we get the first revision for Q2 GDP; Banco de Mexico releases it minutes
Germany reported August IFO business climate survey and final Q2 GDP data; the account of the ECB’s July meeting will be released; U.K. CBI released the results of its August distributive trades survey; Bank of Israel remains hawkish
BOJ officials remain dovish; New Zealand reported weak Q2 retail sales; China announced a massive CNY1 trln stimulus package to help shore up the economy; Korea hiked rates 25 bp to 2.5%, as expected

The dollar is slightly softer as China stimulus announcement boosts risk sentiment ahead of Jackson Hole. DXY is trading near 108.38 and is likely to see strong support near 108 even as it remains on track to test the July 14 high near 109.294. The euro continues to have trouble trading much above $1.00 and is currently trading back near $0.9985. We believe it remains on track to test the September 2002 low near $0.9615. Sterling remains heavy as it struggles to move much above $1.18. We believe it remains on track to test the March 2020 low near $1.1410. USD/JPY is trading near 136.50 after it was unable to break above 138 earlier this week. With risk sentiment improving from China stimulus plans and the BOJ remaining ultra-dovish (see below), this pair should move higher to eventually test the July 14 high near 139.40. We maintain our strong dollar call and would fade any dollar weakness heading into tomorrow’s speech by Powell.

AMERICAS

The Kansas City Fed’s Jackson Hole Economic Symposium begins today. This year’s theme is "Reassessing Constraints on the Economy and Policy" and the full agenda will be available online tonight at 8 PM ET. Fed Chair Powell gives his keynote speech tomorrow at 10 AM ET. In the past, the Fed has used this symposium to announce or hint at policy shifts. This year is very different and we do not think the Fed will paint itself into a corner ahead of the September 20-21 FOMC meeting. Rather, we expect Powell to try and manage market expectations by maintaining the Fed’s hawkish tone. Between now and the September 20-21 FOMC meeting, we will get all the major August data and some of the early September surveys such as the preliminary S&P Global PMI readings and regional Fed surveys. The Fed will also have a better idea then of how the economy is doing in Q3. Please see our Jackson Hole preview here.

Fed tightening expectations continue to drift higher. Odds of a 75 bp hike next month are close to 70%, while the swaps market is starting to ever so slightly price in a possible terminal rate above 3.75%. We really don't think Powell will give anything to the doves looking for a pivot. That said, the risks to the price action are asymmetrical as markets are universally positioned for a hawkish speech from Powell tomorrow. Ahead of Jackson Hole, U.S. rates continue to drift higher. The 2-year yield is trading close to 3.40% and is nearing the June high near 3.45%, while the 10-year yield is trading near 3.10%, the highest since late June but short of the June 14 high near 3.50%.

Regional Fed manufacturing surveys for August will continue rolling out. Kansas City reports today and is expected at 10 vs. 13 in July. So far, the readings have been mixed as Empire came in at -31.3 vs. 11.1 in July, Philly Fed came in at 6.2 vs -12.3 in July, and Richmond Fed came in at -8 vs. 0 in July. Yesterday, durable goods order were mixed but the manufacturing sector appears to be holding up, at least for now.

We get the first revision for Q2 GDP. Consensus sees growth improving two ticks to -0.7% SAAR, driven mostly by a half a percentage point improvement in personal consumption to 1.5% SAAR. Of course, this is old news as market are already looking ahead to Q3 and Q4. The Atlanta Fed’s GDPNow model is now tracking 1.4% SAAR growth for Q3 vs. 1.6% previously. However, it’s early on and so each data point can lead to big swings in the estimate. Next update to the model will be released tomorrow. Of note, Bloomberg consensus sees 1.5% SAAR in Q3 and 1.3% SAAR in Q4. Weekly jobless claims will also be reported today.

Banco de Mexico releases it minutes. At that August 11 meeting, the bank hiked rates 75 bp to 8.5%, as expected. The decision was unanimous but the bank said future moves will depend on prevailing conditions. Perhaps the minutes will provide more clues. Yesterday, mid-August CPI came in at 8.62% y/y vs. 8.55% expected and 8.16% in mid-July. Headline inflation is the highest since December 2000 and further above the 2-4% target range. Next policy meeting is September 29 and another 75 bp hike seems likely. The swaps market is pricing in 150 bp of tightening over the next 6 months that would see the policy rate peak near 10.0%. Final Q2 GDP, Q2 current account data, and June GDP proxy will also be reported today.

EUROPE/MIDDLE EAST/AFRICA

Germany reported August IFO business climate survey and final Q2 GDP data. GDP was revised up a tick to 0.1% q/q, while the y/y rate came in at 1.8% vs. 1.5% advance. Private consumption improved to 0.8% q/q and government spending improved to 2.3% q/q, but this was offset by a -1.3% q/q drop in capital investment. Elsewhere, headline IFO came in at 88.5 vs. 86.8 expected and a revised 88.7 (was 88.6 in July), with current assessment at 97.5 vs. 96.0 expected and 97.7 in July and expectations at 80.3 vs. 79.0 expected and a revised 80.4 (was 80.3) in July. September GfK consumer confidence will be reported tomorrow and is expected at -32.0 vs. -30.6 in August.

The account of the ECB’s July meeting will be released. Obviously, markets will be looking for clues about the upcoming meeting next month. Last month, the hawks won out and the ECB delivered a 50 bp hike. Of interest will be the discussions of the so-called Transmission Protection Instrument (TPI). Details have so far been very vague and the account should hold some clues as to how the ECB is viewing its eventual triggers and limitations. Of note, WIRP suggests a 50 bp hike is fully priced in for September 8, with 20% odds seen of a larger 75 bp move. The swaps market is pricing in 200 bp of tightening over the next 12 months that would see the deposit rate peak near 2.0%, up from 1.75% at the start of last week.

The U.K. CBI released the results of its August distributive trades survey. Retailing reported sales came in at 37 vs. -8 vs. -4 in July, while total reported sales came in at 11 vs. -12 in July. Earlier this week, its industrial trends survey was on the weak side with orders at -7 vs. 3 expected and 8 in July and selling prices at 57 vs. 41 expected and 48 in July. Overall, the economy has proven to be more resilient than anticipated, Of note, WIRP suggests a 50 bp hike September 15 is fully priced in, with 30% odds of a larger 75 bp move. 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%, up from 4.0% at the start of this week and 3.25-3.50% at the start of last week. Can the BOE really tighten so aggressively when policymakers are already expecting a recession by Q4? Stay tuned.

Bank of Israel remains hawkish. Deputy Governor Abir said “We think it’s important to be as aggressive and firm at curbing inflation now, rather than paying the price later.” He added that “We are talking about a process, rather than just one more hike. We’re going to front-load that process, so it will probably be quicker, and more in the next few meetings than later on, because we want to try and get ahead of the task of bringing inflation back into the target.” Regarding recent gains in the shekel, Abir noted “We don’t have a target for the exchange rate. Our target is inflation, and that is our primary goal.” The bank just delivered a hawkish surprise this week with a 75 bp hike to 2.0%. The hawkish message was received as the swaps market is now pricing in a terminal rate between 3.0-3.25% vs. 2.25% at the end of last week, which we thought was too low. At the previous meeting in July, bank researchers saw the policy rate at 2.75% in Q2 2023 but that rate path has likely steepened now. Abir added that the bank now believes that there won’t be “a meaningful decline in inflation until the end of 2022.” Next policy meeting is October 3 and a 50 bp hike seems likely, with risks of another hawkish surprise. Updated macro forecasts and rate path will be released as well.

ASIA

Bank of Japan officials remain dovish. MPC member Nakamure said that the current state of the economy doesn’t allow for a change in the bank’s easing bias. He stressed that further wage increases must be confirmed before any change in the BOJ’s forward guidance, repeating the view of many BOJ officials that it’s not just about getting inflation to the 2% target. Nakamura said that Japan should not enter a rate hike competition but noted that Fed rate hikes have been causing high volatility in FX markets. He said the bank will continue to watch for any negative impact on the economy from FX moves. We believe Nakamura’s view represents the consensus and supports our view that current policy will be maintained for the foreseeable future. Next meeting is September 21-22 and no change is expected then.

New Zealand reported weak Q2 retail sales. In volume terms, sales came in at -2.3% q/q vs. 1.7% expected and a revised -0.9% (was -0.5%) in Q1. It was the second straight quarter of weaker sales and raises the odds that the overall economy will also contract. Q2 GDP data will be reported September 15. There is no consensus yet but the contraction will likely be worse than the -0.2% q/q posted in Q1. Of note, WIRP suggests a 50 bp hike to 3.5% by the RBNZ October 5 is about 85% priced in while the swaps market is pricing in a terminal policy rate near 4% over the next 6 months.

China announced a massive CNY1 trln stimulus package to help shore up the economy. The State Council outlined a 19-point package that It is mostly focused on infrastructure spending, including another CNY300 bln that state banks can invest in infrastructure projects that comes on top of another CNY300 bln that was already announced in June. Local governments can issue up to CNY500 bln of special infrastructure bonds from previously unused quotas. The State Council vowed to make use of “tools available in the toolbox” to inject stimulus in a timely and decisive manner. While the measures will help at the margin, we can’t help but feel that policymakers there are pushing on a string. Infrastructure spending is the tried and true method that has helped China muddle through in the past but we suspect it won’t be enough to truly offset the impact of Covid Zero lockdowns, persistent energy shortages from drought, and strains on the financial system from the collapsing property market.

Bank of Korea hiked rates 25 bp to 2.5%, as expected. Governor Rhee reiterated his view that large hikes were no longer required, something he highlighted at the last meeting July 13 after the bank hiked rates 50 bp. Rhee said the bank would continue with 25 bp hikes going forward, adding that the policy rate has already reached the middle of what it considers to be its neutral range. Rhee said that after reaching the upper part of that range, the bank will then consider if it needs to go higher. The bank raised its average inflation forecast for this year to 5.2% vs. 4.5% previously and cut its growth forecasts for this year and next slightly. Regarding the weak won, Rhee said “I expect the 25 bp hike will help rein in the currency rate. We don’t target a certain currency level, but we do consider its impact on inflation.” The swaps market is pricing in 75 bp of tightening over the next 6 months that would see the policy rate peak near 3.25%, up from 2.75% at the start of this week.

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