Dollar Steady Ahead of BOE Decision

August 05, 2021
  • We got further confirmation that the FOMC is tilting more hawkish; U.S. Treasury quarterly refunding announcement came in as expected; ISM reported strong July services PMI but ADP jobs report suggests some caution is warranted; Brazil COPOM hiked rates 100 bp to 5.25%, as expected
  • BOE decision is due out shortly; new macro forecasts will be released and could hold some clues about policy; eurozone reported firm economic data; Czech National Bank is expected to hike rates 25 bp to 0.75%.
  • Australia reported June trade data; political uncertainty is picking up in Malaysia

The dollar is steady ahead of the BOE decision. DXY recorded an outside up day yesterday and built on that today to trade at the highest level since July 28 near 92.35. The euro recorded an outside down day yesterday and remains heavy just below $1.1850, while sterling has held up slightly better and is trading just above $1.39. As such, the EUR/GBP cross is trading at recent lows around .8500. USD/JPY broke below the key 109.05 yesterday, only to reverse higher to post an outside up day and traded near 109.75 today. We remain positive on the dollar, as stronger U.S. data and hawkish Fed comments are clearly taking hold (see below).

AMERICAS

We got further confirmation that the FOMC is tilting more hawkish. Last Friday, it was Bullard. Early this week, it was Waller. Yesterday, it was Vice Chair Clarida as he said “If my baseline outlook does materialize, then I could certainly see supporting announcing a reduction in our purchases later this year.” He said tapering talks will continue in the coming meetings and added that under his baseline, the “necessary conditions for raising the target range for the federal funds rate will have been met by year-end 2022.” Lastly, Clarida said that risks to his inflation outlook are to the upside.

Clarida up until now has tilted very dovish and so his comments are significant. He rarely dissents from Powell and so we view this as a sign that the Fed Chair is also moving in this direction. Furthermore, Kaplan said “As long as we continue to make progress in July (jobs) numbers and in August jobs numbers, I think we’d be better off to start adjusting these purchases soon.” For those keeping score at home, we now have Bullard, Waller, Clarida, Kaplan, and Evans pretty much on board with tapering in 2021 and rate hikes by late 2022 or early 2023. More Fed officials will likely move into this came in the coming weeks, though this is of course data-dependent. Today, Waller and Kashkari speak and will likely offer contrasting views on policy.

The U.S. Treasury quarterly refunding announcement came in as expected. It will sell a total of $126 bln of long-term securities next week, consisting of $58 bln of 3-year notes Tuesday, $41 bln of 10-year notes Wednesday, and $27 bln of 30-year bonds Thursday, all unchanged from May. The auctions will raise $67.4 bln in new cash, though Treasury noted that “Continuing current issuance sizes and patterns may provide more borrowing capacity than is needed to address borrowing needs over the intermediate-to-long term” and expects to announce a reduction in auction sizes as soon as November.

The Treasury also reiterated Treasury Secretary Yellen’s recent warning about the debt ceiling. It acknowledged that it faces “considerable uncertainty” about how long it can delay a default through special accounting measures after the federal debt ceiling was reinstated this past Sunday. Treasury said it couldn’t provide a “specific estimate of how long extraordinary measures will last.”

ISM reported strong July services PMI. The headline reading rose to a record high 64.1 vs. 60.5 expected. The components were strong across the board, with employment rising to 53.8 vs. 49.3 in June. Prices paid rose to 82.3 vs. 79.5 in June, the highest since 2005. Sustained readings above 60 are rare for all these PMIs, and yet here we are with five straight months of services above 60. Recall that July ISM manufacturing fell in July to 59.5 from 60.6 in June even as the employment component recovered to 52.9 from 49.9 in June. All of these PMI readings remain at historically high levels, signifying continued strength in the U.S. economy.

ADP jobs report suggests some caution is warranted, however. ADP came in at 330k vs. 690k and a revised 680k (was 692k) in June. The major clues are now in for Friday jobs report, with consensus at 870k jobs added vs. 850k in June. Keep an eye on hourly average earnings, which are expected to pick up to 3.9% y/y vs. 3.6% in June. Weekly jobless claims will be reported today, with initial claims expected at 383k vs. 400k the previous week and continuing claims expected at 3.255 mln vs. 3.269 mln the previous week. Claims data have been erratic lately, increasing the risk of a big NFP miss on Friday. June trade data and July Challenger job cuts will also be reported today, while Canada reports June trade data.

Brazil COPOM hiked rates 100 bp to 5.25%, as expected. it also flagged a hike of similar magnitude at the next meeting September 22. Bloomberg consensus sees the policy rate peaking at 6.75% by end-2021. However, there are clear upside risks as inflation continues to accelerate to 8.59% y/y in mid-July, well above the 2.25-5.25% target range. Elsewhere, the fiscal outlook remains cloudy after President Bolsonaro pledged to increase the Bolsa Familia social program by at least 50%. This also argues for tighter monetary policy ahead.

EUROPE/MIDDLE EAST/AFRICA

Bank of England decision is due out shortly. We expect a dovish hold, as uncertainty over the recent reopening and the end of the job furlough program next month warrants some caution. However, the U.K. economy is faring well and so there is some risk that Saunders and Ramsden dissent to end QE early given their recent comments. At the last decision June 24, the bank delivered a dovish hold. While no one was expecting any policy changes after it announced the start of tapering at the previous decision May 5, the dovish tone took many by surprise. The bank warned against “premature tightening” due to its view that the spike in inflation is temporary, noting that “Financial market measures of inflation expectations suggest that the near-term strength in inflation is expected to be transitory.” The bank reiterated that it does not intend to hike rates until inflation has risen above the 2% target for a sustained period. We believe this forward guidance will be maintained as it would be surprising to see yet another about-face from the BOE at this meeting.

New macro forecasts will be released and could hold some clues about policy. The previous inflation forecasts from May were 2.5% in 2021, 2.0% in 2022, and 2.0% in 2023, while the previous GDP growth forecasts were 7.25% in 2021, 5.75% in 2022, and 1.25% in 2023. If the bank increases these forecasts significantly, it would imply that inflation is not as transitory as it previously thought and that tightening could come even earlier than expected. As it is, the short sterling futures strip suggests some odds of the first hike in Q4 2021, rising significantly in Q1 and fully priced in by Q2 2022.

Eurozone reported firm economic data. German June factory orders rose 4.1% m/m vs. 2.0% expected and a revised -3.2% (was -3.7%) in May. Elsewhere, French June IP rose 0.5% m/m, as expected and up from a revised -0.4% (was -0.3%) in May. Germany (0.6% m/m expected), Spain (0.5% m/m expected), and Italy (1.0% m/m expected) report IP tomorrow but the headline eurozone reading won’t come out until August 12.

Czech National Bank is expected to hike rates 25 bp to 0.75%. Inflation eased a tick to 2.8% y/y in June, the lowest since March and further within the 1-3% target band, while Q2 GDP growth disappointed at only 0.6% q/q. Yet officials seem willing to go ahead with an aggressive tightening cycle. Deputy Governor Nidetzky backs a hike this week and “can imagine” hikes at each subsequent policy meeting until new factors emerge. Bloomberg consensus sees a policy rate of 0.75% at year-end, 1.0% by mid-2022 and 1.50% by end-2022, which seems too dovish a path in light of the more hawkish central bank comments.

ASIA

Australia reported June trade data. Exports rose 4% m/m vs. 6% expected and a revised 4% Was 6%) in May, while imports rose 1% vs. 4% expected and 3% in May. As a result, the trade surplus widened to a record high AUD10.5 bln. Exports to China rose 8.2%, driven mostly by iron ore. Iron ore exports rose 6.2% and coal exports jumped 15.5%. July and August exports are likely to show some weakness, however, as iron ore prices are down nearly 25% from the late June peak. Strength in the external sector is welcome as domestic activity is taking a hit from the lockdowns. Melbourne just announced a 7-day lockdown due to rising infections, putting nearly two thirds of the nation’s population under lockdown.

Political uncertainty is picking up in Malaysia. Prime Minister Muhyiddin lost the support of UMNO, the largest party in the ruling National Front. However, he refused to step down and claims to still have enough support to win a vote of confidence, which he set for next month. At this point, it’s unclear how many UMNO members will vote against Muhyiddin, as he claims only 8 have committed to support a no confidence motion. UMNO officials said that number has grown. Of the 220 seats in parliament, UMNO holds 38 but we know that it is split on Muhyiddin. How big that split is will be crucial, as popular discontent is rising along with the widening pandemic.

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