Dollar Steady Ahead of ECB Decision

July 22, 2021
  • U.S. 10-year yield is trading around 1.30%; central bank divergence will be underscored today with the ECB decision; weekly initial jobless claims will be closely watched; Fed manufacturing surveys for July will continue to roll out; Republican Senators blocked debate on the infrastructure package; a battle over the debt ceiling is brewing; Mexico reports mid-July CPI data; Colombia announced a $4 bln tax plan to shore up public finances
  • The ECB decision should bring hints of further easing; we expect the ECB to announce a variety of measures today; U.K. CBI released the results of its July industrial trends survey; South Africa is expected to keep rates steady at 3.5%
  • Australia reported preliminary June trade data and Q2 NAB business confidence; Indonesia kept rates on hold at 3.5%, as expected

The dollar is steady ahead of the ECB decision shortly. DXY is trading just below 93 after trading yesterday at the highest level since April 1 near 93.191. Further gains are expected and it should eventually test the March 31 high near 93.437. The euro remains heavy ahead of the ECB decision and clean break below $1.18 sets up a test of the March 31 low near $1.1705. Sterling has recovered and is trading near $1.3760 after strong support was seen just below $1.36. Despite this bounce, we continue to look for a test of the February low near $1.3565. USD/JPY continues to trade above 110 as risk off sentiment ebbs.

AMERICAS

The U.S. 10-year yield is trading around 1.30%, up from Tuesday's intra-day low near 1.13%. That's quite a move and is another reflection (along with higher equities and USD/JPY) of the recovery in risk sentiment. The virus news stream remains negative but we think fears of another global shutdown are overblown.

Central bank divergence will be underscored today with the ECB decision. It is likely to pledge steady rates for an extended period of time (see below). Last week, the BOJ suggested that it would keep rate steady until at least FY24. Soft U.K. data should see the BOE deliver a dovish hold August 5. Meanwhile, the U.S. outlook remains strong and the Fed is likely to continue moving towards tapering at the July 27-28 FOMC meeting. All of these developments favor the dollar.

Weekly initial jobless claims will be closely watched. That’s because the readings are for the BLS survey week containing the 12th of the month. Consensus sees 350k vs. 360k the previous week. Continuing claims are reported with a one-week lag and are expected at 3.1 mln vs. 3.241 mln the previous week. If so, both readings would be new cycle lows and would underscore continued improvement in the labor market. Consensus currently sees +750k jobs in July vs. +850k in June, with the unemployment rate seen falling a couple of ticks to 5.7%.

Fed manufacturing surveys for July will continue to roll out. Kansas City is expected at 25 vs. 27 in June. So far, Empire manufacturing came in at 43.0 vs. 17.4 in June and Philly Fed came in at 21.9 vs. 30.7 in June. Markit preliminary July PMI readings will be reported tomorrow. Manufacturing is expected at 62.0 vs. 62.1 in June, while service is expected at 64.5 vs. 64.6 in June. June Chicago Fed National Activity Index (0.30 expected), leading index (0.8% m/m expected), and existing home sales (1.7% m/m expected) will also be reported today.

As expected, Republican Senators blocked debate on the infrastructure package. The final vote was 49-51, with Majority Leader Schumer voting no in a procedural move that will allow him to bring up the measure again. Yet the package is not dead as some centrist Republicans said an agreement was likely before the weekend. Centrists from both parties continue to hammer out a compromise. Reports have emerged that about a dozen Senate Republicans sent Schumer a pledge to advance the bill on the floor once it has been completed.

A battle over the debt ceiling is brewing. Senate Minority Leader McConnell reportedly believes all his Republican colleagues will vote against raising the ceiling, which is needed to allow the government to continue its borrowing. Democrats need ten Republicans to cross over in order to get the 60 votes needed to overcome a filibuster. However, some GOP members are trying to tie raising the debt ceiling to enacting spending cuts. The ceiling was suspended two years ago but that suspension expires July 31. Some accounting tricks could allow the government to continue functioning for some time, but Congressional Budget Office estimated yesterday that the cash crunch is likely to come in October or November. Stay tuned.

Mexico reports mid-July CPI data. Headline inflation is expected at 5.65% y/y vs. 6.02% in mid-June. If so, it would be the lowest since March and slightly closer to the 2-4% target range. Next policy meeting is August 12 and no change is expected if price pressures continue to ease. The decision to hike last month was 3-2 and so we think another move so soon would be very difficult to engineer. Meanwhile, new Finance Minister Ramirez is showing little willingness to utilize fiscal stimulus and so Banco de Mexico will be under great pressure not to remove accommodation too quickly.

The Colombian government announced a $4 bln tax plan in an attempt to shore up public finances, but protestors are already out against it. The proposal is far less ambitious than the original one in April, but it shows the desire of the government to turn around the fiscal situation after the rating downgrade by Fitch from IG to HY (the second agency to do so). Let’s see how the peso opens but it could get bumpy today.

EUROPE/MIDDLE EAST/AFRICA

The ECB decision should bring hints of further easing. Expectations are running high after ECB President Lagarde last week said that this meeting will now have “some interesting variations and changes.” She added that “It’s going to be an important meeting. Given the persistence that we need to demonstrate to deliver on our commitment, forward guidance will certainly be revisited.” Lagarde also said that she expects the current EUR1.85 trln PEPP to run “at least” until March 2022 but that it could then be followed by a “transition into a new format” without elaborating further. Lastly, she said “We need to be very flexible and not start creating the anticipation that the exit is in the next few weeks, months.”

We expect the ECB to announce a variety of measures today. We expect updated forward guidance that basically pledges to keep rates steady through at least 2022. The language should also reflect its newfound willingness to allow inflation to temporarily run above the 2% target, though it will fall short of the Fed’s average inflation targeting framework. We also think there is a chance that the ECB extends its asset purchases beyond the planned end of PEPP by somehow folding it into the existing and ongoing APP. New macro forecasts were just presented at the June 10 meeting and so won’t be updated until the September 9 meeting. As such, it’s possible that the ECB announces some of these changes now with details to be revealed at the next meeting. We could see some “sell the rumor, buy the fact” price action after the decision but make no mistake, the ECB’s actions will ultimately result in a weaker euro.

The U.K. CBI released the results of its July industrial trends survey. The readings eased slightly more than expected as business optimism came in at 27 vs. 34 expected and 38 in June. Total orders came in at 17 vs. 16 expected and 19 in June, while selling prices came in at 42 vs. 44 expected and 46 in June. The economy appears to be losing some steam even as Freedom Day heralds a return to more normal life. June retail sales and July PMI readings tomorrow are also expected to show some softness, which should keep policymakers on alert. Next Bank of England meeting is August 5 and we expect a dovish hold. Today, Deputy Governor Broadbent said the bank is probably right to look through the current spike in inflation, as many of the increases are likely to be temporary.

South African Reserve Bank is expected to keep rates steady at 3.5%. Yesterday, June CPI came in at 4.9% y/y vs. 4.8% expected and 5.2% in May. It was the first deceleration since February and moves closer to the center of the 3-6% target band. The bank continues to talk about starting the tightening cycle this year but the market sees 2022 lift-off. The current environment is simply not conducive for tighter policy, with risks of further social unrest still quite high. Bloomberg consensus sees steady rates through this year, with the first hike seen in Q1 2022 and another two hikes by end-2022 that would take the policy rate to 4.25%.

ASIA

Australia reported preliminary June trade data and Q2 NAB business confidence. The trade surplus rose to a record AUD13.3 bln ($9.75 bln) in June. Exports rose 8%, driven largely by strength in iron ore, coal, and other commodities. The jump in iron ore shipments to a record AUD17.6 bln is welcome news as concerns remain high about a slowdown in the mainland Chinese economy. Imports also rose 8%, driven largely by petroleum. Elsewhere, NAB business confidence fell to 17 from a revised 19 (was 17) in Q1. For now, the economy remains in solid shape but policymakers will be watching to see how the recent lockdowns impact growth in Q3. Next RBA meeting is august 3 and no change is expected then.

Bank Indonesia kept rates on hold at 3.5%, as expected. It also lowered its growth outlook and now expects GDP to rise in a range of 3.5-4.3% for the year, down from a forecast of 4.1-5.1% from before the latest virus wave. Governor Warjiyo said “pro-growth” policy will be maintained into next year and also emphasized the need to “maintain exchange rate stability” given heightened uncertainty in global markets. We don’t see any policy changes from Indonesia until we get more clarity on the spread of the delta variant, which will take a while. Bloomberg consensus sees steady rates through this year, with the first hike seen by mid-2022 and another hike by end-2022. There was little reaction to the news with IDR up 0.3% against the dollar, in line with the broad moves across the region.

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