Dollar Soft as Markets Await Fresh Drivers

August 20, 2024

Win Thin

Markets are positioning for a dovish message out of Jackson Hole; global PMIs Thursday could be a big wakeup call for the markets; Canada highlight will be July CPI data
ECB Governing Council member Rehn spoke; Riksbank cut rates 25 bp to 3.5%, as expected; Turkey is expected to keep rates steady at 50.0%
Japan’s ruling LDP fixed its leadership election date for September 27; RBA released its minutes; New Zealand reported solid July trade data

The dollar remains soft as markets await fresh drivers. DXY is trading lower for the third straight day near 101.811 as markets position for a dovish message out of Jackson Hole (see below). SEK is outperforming despite a dovish cut from the Riksbank (see below). USD/JPY is trading lower near 146.40, sterling is trading flat near $1.30, and the euro is trading lower near $1.1080. While Powell is widely expected to signal a rate cut in September, we continue to believe that markets are overly pessimistic about the U.S. economy. Indeed, retail sales data last week showed that the primary driver of growth remains on firm footing. Looking at the totality of the data, the economy is still growing near trend and suggests the market is once again getting carried away with its pricing for aggressive easing (see below). We continue to believe that the divergence story remains in place and should continue to support the dollar. However, it will likely take weeks for the current market narrative to run its course. Last week’s data provided a good start but more needs to be seen.

AMERICAS

Markets are positioning for a dovish message out of Jackson Hole. Given the lack of any topline economic data to refute the dovish Fed pricing, the path of least resistance for the dollar is down. Yet Fed comments over the past several weeks show officials remain constructive on the U.S. outlook and that the likely easing path will be one of prudence and gradualism. As a result, markets positioning for a dovish speech Friday from Powell may be caught wrong-footed. We will be sending out our Jackson Hole preview shortly.

Global PMIs Thursday could be a big wakeup call for the markets. We continue to believe that the U.S. economy remain in solid shape and likely to outperform within the majors. We do not see imminent recession, which is what would be needed to get the Fed to cut as much as the market is pricing in. While the odds of a 50 bp cut in September have fallen (25% for Fed Funds futures, 10% for OIS), nearly 100 bp of total easing by year-end is still priced in, along with 175-200 bp of total easing over the next 12 months. This mispricing should eventually correct. Only U.S. data today is August Philly Fed services index, which stood at -19.1 in July.

Canada highlight will be July CPI data. Headline is expected at 2.5% y/y vs. 2.7% in June, core median is expected at 2.5% y/y vs. 2.6% in June, and core trim is expected at 2.8% y/y vs. 2.9% in June. If so, it would be the second straight deceleration in headline to the lowest since March 2021. The Bank of Canada projects headline and core (average of trim and median CPI) inflation to average 2.3% y/y and 2.5% y/y in Q3, respectively. Slowing inflation in July would cement market pricing for an additional 75 bp of easing by year-end and curtail CAD upside.

EUROPE/MIDDLE EAST/AFRICA

ECB Governing Council member Olli Rehn spoke. Rehn warned “in my view, the recent increase in negative growth risks in the euro area has reinforced the case for a rate cut at the next ECB monetary policy meeting in September - provided that disinflation is indeed on track.” We agree. The swaps market has fully priced in a 25 bp cut in September for several weeks now.

Riksbank cut rates 25 bp to 3.5%, as expected. However, the Riksbank warned that “the policy rate can be cut two or three more times this year, which is somewhat faster than the Executive Board assessed in June.” This was basically the same as before and so the Riksbank just tacked on another 25 bp of expected easing this year. The swaps market was right all along and expects 75 bp of cuts by year-end. With inflation in Sweden tracking the Riksbank’s forecasts, we doubt the bank will deliver more easing than is currently priced in. Updated macro forecasts will come at the September 25 meeting.

Turkey central bank is expected to keep rates steady at 50.0%. At the last meeting July 23, the central bank left rates steady at 50.0% for the fourth straight time and warned that inflation pressures “remain alive.” The bank stressed that “The tight monetary stance will be maintained until a significant and sustained decline in the underlying trend of monthly inflation is observed, and inflation expectations converge to the projected forecast range. Monetary policy stance will be tightened in case a significant and persistent deterioration in inflation is foreseen.” Despite this cautious guidance, the market is still pricing in the start of an easing cycle over the next three months.

ASIA

Japan’s ruling Liberal Democratic Party election committee fixed its leadership election date for September 27. The campaign period will begin September 12. Whoever wins the LDP leadership contest will become the new Prime Minister. General elections aren’t due until 2025, but it’s possible the new Prime Minister calls early elections to their solidify support.

Reserve Bank of Australia released its minutes. At the August 6 meeting, the bank delivered a hawkish hold. Minutes showed that members discussed the options of raising the cash rate target or holding it steady. The case to raise the cash rate was supported by persistent underlying inflation and to counter market expectations that the cash rate would be lowered several times later in 2024. Ultimately, members decided that the case to leave the cash rate target unchanged was the stronger one. Members also agreed that “it was unlikely that the cash rate target would be reduced in the short term, and that it was not possible to either rule in or rule out future changes in the cash rate target.” The swaps market continues to imply about 90% probability of a 25 bp cut by year-end. That’s about right in our view.

New Zealand reported solid July trade data. Exports rose 14.3% y/y and imports rose 8.5% y/y, leading to a monthly deficit of -NZD963 mln. However, the 12-month deficit narrowed to a 27-month low of -NZD9.293 bln, which should lead to a further modest reduction in New Zealand’s large current account deficit (which totaled -6.8% of GDP in Q1). Over time, this should lessen the drag on NZD. Of note, exports to China rose 8.5% y/y, while exports to Australia rose 19.0% y/y.

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