- US CPI to firm, not heat up. USD risks skewed to the downside.
- RBA and Norges Bank to deliver hawkish holds. AUD, NOK still carry the edge.
- GBP needs a UK GDP beat to gain upside traction.
USD and Treasury yields were knocked lower on Friday as labor demand unexpectedly declined in July. Nonfarm payrolls (NFP) fell -23k (consensus: +80k) and employment gains in June and May combined was 103k lower than previously reported. As such, NFP gains in the three months to July averaged just +20k per month.
Part of the reason behind the big NFP miss in July was driven by an unusual -50k decline in local government education jobs, a category that had shown little net change over the prior twelve months. But stripping out that distortion does little to improve the underlying picture: job creation is weak. The silver lining is that layoffs are historically low, reinforcing the low-hire, low-fire backdrop.
That keeps the Fed in a balancing act, with this week’s US July CPI a key swing factor for Fed funds rate expectations. Fed funds futures currently price in 44% odds of a 25bps hike in September, down from a high of 75% end-July, and just over 40bps of cumulative tightening in the next twelve month.
A soft US CPI print would strengthen the case for a dovish repricing in Fed hike expectations and further undermine USD. A hot US CPI print may deliver a kneejerk USD bounce via higher front-end yields. However, with Fed policy already restrictive (assuming a neutral rate of 3.00%), the scope for a material hawkish repricing looks limited which is a USD headwind.
US July CPI: Firmer, Not Hotter
US July CPI to firm modestly but stop short of signaling a renewed acceleration in inflation (Wednesday). Headline CPI is expected to rise +0.1% m/m vs. -0.4% in June and ease to 3.4% y/y vs. 3.5% in June. Core CPI is expected to rise +0.2% m/m vs. 0.0% in June and ease to 2.5% y/y vs. 2.6% in June.
The July pick-up in the ISM Services Prices Paid index suggests upside risks to inflation have yet to fully recede. However, the slowdown in US wage growth combined with strong productivity growth remains an important disinflationary force by containing unit labor costs.
The three-month change in core and headline CPI will offer a cleaner read on whether inflation momentum is genuinely decelerating or reaccelerating. Moreover, CPI measures which filter out extreme price swings, like trimmed mean, median, sticky, and super core will be key to judging the underlying inflation trend.
July PPI (Thursday) and August University of Michigan sentiment survey (Friday) will round out the inflation picture, while the July retail sales report (Friday) is expected to remain consistent with resilient consumer spending activity.
The policy relevant control-group sales - which exclude cars, gas, food services, and building materials – is seen rising 0.3% m/m vs. 0.5% in June. The risk is that slower wage growth starts to squeeze real incomes and consumer spending if inflation quickens again.
RBA and Norges Bank to Hold
Favorable interest rate carry in Australia and Norway continue to make AUD and NOK two of the most attractive currencies across the majors. NOK and AUD rank first and second, respectively, on the G10 FX leaderboard year-to-date.
The RBA is widely expected to keep the policy rate at 4.35% for a second straight meeting (Tuesday). The RBA is also poised to reiterate that it’s prepared to “increasing the cash rate further if needed” because inflation continues to exceed 3.0%. The RBA’s August Statement on Monetary Policy will shed light on the bank’s inflation and growth outlook.
RBA cash rate futures imply about 50% odds of one final 25bps hike by year-end. The RBA has room to pause its tightening cycle. First, the RBA projects real GDP growth to be below potential over the next two years. Second, RBA cash rate at 4.35% currently sits near the top of the range of model-based estimates of the nominal neutral rate.
The Norges Bank is expected to leave the policy rate at 4.25% for a second straight meeting (Thursday). Markets price in 25% odds of a 25bps hike this week, but Norway’s July CPI data (Monday) could still reshape Norges Bank rate expectations.
At its last June 17 meeting, the Norges Bank indicated “it will likely be necessary to raise the policy rate further at one of the forthcoming monetary policy meetings.” The Norges Bank sees the policy rate peak at 4.55% by year-end, which is in line with the pricing from the swaps curve.
UK Growth Pulse
UK real GDP growth to slow in Q2 (Thursday). Consensus is for real GDP to rise 0.4% q/q vs. 0.6% in Q1. The Bank of England (BOE) projects a softer print of 0.3% q/q as lower household real income growth, and tighter financial conditions weigh on domestic demand activity. The BOE forecasts consumption growth to ease to 0.3% q/q in Q2 vs. 0.6% in Q1.
The swaps curve continues to imply 50bps of BOE tightening to 4.25% in the next twelve months. That would leave the policy rate above the BOE’s estimated neutral range (2.00%-4.00%) when the UK economy is operating well below potential. As such, absent a GDP beat, UK rate pricing looks vulnerable to a dovish repricing against GBP.
