Dollar Steadies Ahead of Weekend

July 30, 2021
  • Core PCE data for June will be the highlight; July Chicago PMI will also be reported; Q2 GDP was disappointing but still robust; Colombia is expected to keep rates steady at 1.75%; our cautious stance on Peru was warranted
  • Key inflation readings were reported in the eurozone; the coming months will be the first test of the ECB’s new policy framework; eurozone reported firm Q2 GDP data
  • Japan reported firm June data; Korea posted strong IP data; Thailand’s current account deficit was narrower than expected; China reports official July PMI Saturday local time

The dollar is steadying ahead of the weekend. DXY is flat after four straight down days and is trading just below 92. The euro is trading at the highest level since June 30 just above $1.19 and a clean break above $1.1890 would set up a test of the June 25 high near $1.1975. The sterling rally is running into resistance at the June 23 high near $1.40 but a break above that would set up a test of the June 1 high near $1.4250. USD/JPY remains heavy near 109.50 and a clean break below 109.65 would set up a test of the July 19 low near 109.05. While we remain positive on the dollar, we acknowledge that the rally is unlikely to resume in force until a more hawkish Fed narrative takes hold.

AMERICAS

Core PCE data for June will be the highlight. It is expected to accelerate to 3.7% y/y vs. 3.4% in May. If so, it would be the highest since February 1991 and nearly double the Fed’s 2% target. Given the upside surprises in CPI and PPI, we believe the same risks hold for core PCE. Personal income and spending will be reported at the same time and are expected at -0.3% m/m and 0.7% m/m, respectively. Final July University of Michigan consumer sentiment (80.8 expected) will also be reported. The preliminary reading saw an unexpected big drop to 80.8 from 85.5 in June, as inflation concerns seemed to top improvement in the labor market.

July Chicago PMI will also be reported. It is expected at 64.1 vs. 66.1 in June. Of note, Markit preliminary July PMI readings were reported last week, with manufacturing coming in at 63.1 vs. 62.0 expected and 62.1 in June and services coming in at 59.8 vs. 64.5 expected 64.6 in June. This dragged the composite PMI down to 59.7 from 63.7 in June. Next Monday sees ISM manufacturing (60.8 expected) and Wednesday see ISM services PMI (60.5 expected). Of note, all of these readings remain at historically high levels, signifying continued strength in the economy. Sustained readings above 60 are rare for all these PMIs.

Q2 GDP was disappointing but still robust. Growth came in at 6.5% SAAR vs. 8.5% expected and a revised 6.3% (was 6.4%) in Q1. The Atlanta Fed’s GDPNow model will start forecasting Q3 growth in the coming days, while the New York Fed’s Nowcast model currently estimates Q3 growth at 4.1% SAAR. Of note, Bloomberg consensus sees SAAR growth of 7.1% in Q3 and 5.1% in Q4 but we suspect those will edge lower in light of the Q2 surprise. On the other hand, more fiscal stimulus is on the way in H2 and so that will add to the tailwinds.

Colombia central bank is expected to keep rates steady at 1.75%. CPI rose 3.63% y/y in June, the highest since March 2020 and nearing the top of the 2-4% target range. At the last meeting June 28, the bank kept rates steady and Governor Villar said inflation expectations remain anchored and that the spike in inflation is likely temporary. This is a dovish contrast to most other banks in the region, which have started tightening cycles. That said, Bloomberg consensus sees the first hike coming by year-end, followed by quarterly hikes next year that take the policy rate to 3.0% by end-2022.

Our cautious stance on Peru was warranted. New president Pedro Castillo named his cabinet but not the Economy Minister. Many observers were certain that his high-profile advisor Pedro Francke would get the job and underpin what seemed like a shift to the center, but now it all looks far more uncertain. On top of this, Castillo made several picks from the far-left to key posts including the Prime Minister (Guido Bellido) and Foreign Affairs Minister (Hector Bejar). The growing sense of unease can be seen in Peru’s longer dated bonds, which have been selling off for the last several sessions and accelerated the move yesterday. The yield on the 2031 bond rose to about 2.7% yesterday, a level not seen since mid-June.

EUROPE/MIDDLE EAST/AFRICA

Key inflation readings were reported in the eurozone. Eurozone July CPI Friday. Headline inflation rose 2.2% y/y vs. 2.0% expected and 1.9% in June. While this appears worrisome, core inflation slowed a couple of ticks as expected to 0.7% y/y. There were clearly upside risks to the headline reading, as France earlier reported headline inflation (EU Harmonized) of 1.6% y/y vs. 1.4% expected, while Germany yesterday reported it at 3.1% y/y vs. 2.9% expected and 2.1% in June. If so, it would be the highest since October 2011.

These coming months will be the first test of the ECB’s new policy framework. Headline eurozone inflation is the highest since October 2018 and above the 2% target. Back in 2018, inflation peaked that month and quickly moved back below 2%. Now, inflation is expected to remain above 2% for some time, though how long is still open to question. The ECB will tolerate a “transitory” move above the target but the new strategy is full of strategic ambiguity. While an extended period would try the patience of the ECB hawks, it’s clear that the doves are firmly in control and that accommodative policy will continue for the foreseeable future.

Eurozone reported firm Q2 GDP data. Headline GDP grew 2.0% q/q vs. 1.5% expected and -0.3% in Q1. Looking at the country breakdown, Germany underperformed, growing 1.5% q/q vs. 2.0% expected and a revised -2.1% (was -1.8%) in Q1, while France grew close to consensus at 0.9% q/q vs. 0.8% expected and a revised flat reading (was -0.1%) in Q1. Spain and Italy were the biggest upside surprises, with the former growing 2.8% q/q vs. 2.1% expected and -0.4% in Q1 and the latter growing 2.7% q/q WDA vs. 1.3% expected and a revised 0.2% (was 0.1%) in Q1. While the cyclical recovery from the pandemic continues, it’s clear that eurozone policymakers remain concerned about the medium-term growth outlook.

ASIA

Japan reported firm June data. Unemployment rate was expected to remain steady at 3.0% but instead fell a tick to 2.9%, while the job-to-applicant ratio was seen rising a tick to 1.10 but instead rose to 1.13. IP rose 6.2% m/m vs. 5.0% expected and -6.5% in May, while retail sales rose 3.1% m/m vs. 2.7% expected and -0.3% in May. Lastly, housing starts rose 7.3% y/y vs. 6.8% expected and 9.9% in May. While the data are encouraging, lockdowns have been extended through the end of August due to surging virus numbers, suggesting that the June strength will likely be short-lived. We continue to look for another fiscal package in the coming weeks.

On the data front, South Korea posted strong industrial production figures and Thailand’s current account deficit was narrower than expected. Korea’s IP for declined from 14.9% y/y in May to 11.9% in June, but still beat the 9.6% consensus by a solid margin. In Thailand, the current account deficit narrowed to -$1.3 bln in June, far lower than the -$2.0 bln expected. This was due to an acceleration of exports (to 46.1% y/y) and a decline in imports (to 45.8% y/y), but note that both remain at very strong levels.

China reports official July PMI Saturday local time. Manufacturing is expected to fall a tick to 50.8. Markets should be prepared for softer mainland data in H2, as the surprise PBOC RRR cut suggests the economy is slowing more than desired. Of note, the Politburo stressed that monetary policy will keep liquidity reasonable and sufficient and pledged support for struggling small businesses and industries struggling. The external backdrop was described as “becoming even more complicated and grim” due to the pandemic. The July meeting of the 25-member Politburo is typically a review of the economy in H1 that helps set policy for H2. There was no mention of the tech crackdown, though separately, the Transport Ministry said it will step up oversight of ride-hailing and on-demand trucking companies.

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