We believe the dollar uptrend remains intact. The greenback finally got some traction last week from the hawkish Fed communication effort as well as the stronger than expected economic data. We believe that the strong jobs data last week sets the tone for the dollar’s near-term outlook and was a key part of reestablishing the Fed’s credibility and hawkishness.
AMERICAS
Markets are still digesting last week’s blockbuster jobs report. Nearly a million jobs were added in the past two months, driving the unemployment down to a new cycle low of 3.5%. More importantly, wages continue to grow nicely and should help support consumption. While a strong labor market does not preclude a recession, it does drive home the point that the Fed will have more confidence to continue tightening policy in order to bring inflation down.
Fed speakers will continue spreading the hawkish message. Evans and Kashkari speak Wednesday. Daly speaks Thursday. Over the weekend, Daly remained hawkish and said the Fed is “far from done” in terms of addressing inflation. What we saw last week was a master class in central bank communication. The Fed was unhappy with the market’s interpretation of the July FOMC decision and went all out in a unified and credible manner to convey this. We expect this communication effort to continue for the foreseeable future.
Fed tightening expectations continue to adjust. WIRP now showing over 80% odds of a 75 bp hike at the September 20-21 FOMC meeting. Looking ahead, the swaps market is now pricing in a 3.75% terminal rate vs. 3.5% at the start of last week. We think this is the correct read and if the market gives the Fed 75 bp next month, the Fed will take it. Market is still pricing in a quick turnaround by the Fed into an easing cycle in H1 2023. It's pretty clear that the Fed doesn't see it that way and the data bear that out, at least for now. Market should also reprice these easing expectations in the coming days and weeks.
U.S. inflation data take center stage this week. July CPI will be reported Wednesday. Headline is expected at 8.7% y/y vs. 9.1% in June, while core is expected at 6.1% y/y vs. 5.9% in June. PPI will be reported Thursday. Headline is expected at 10.4% y/y vs. 11.3% in June, while core is expected at 7.7% y/y vs. 8.2% in June. While some inflation measures are showing signs of turning lower, it is way too early for the Fed to declare victory.
Other minor data will be reported. Q2 nonfarm productivity and unit labor costs will be reported Tuesday. June wholesale inventories, trade sales, and July budget will be reported Wednesday. Weekly jobless claims will be reported Thursday. July import/export prices and preliminary August University of Michigan consumer sentiment will be reported Friday. Headline is expected to rise a point to 52.5, driven largely by a solid rise in expectations.
EUROPE/MIDDLE EAST/AFRICA
U.K. data dump begins this week. Q2 GDP, June construction output, IP, index of services, and trade will all be reported Friday. GDP is expected at -0.2% q/q vs. 0.8% in Q1, while the y/y rate is expected at 2.8% vs. 8.7% in Q1. Construction is expected at -2.0% m/m vs. 1.5% in May, IP is expected at -1.4% m/m vs. 0.9% in May, and services is expected at -1.0% m/m vs. 0.4% in May. At this point, a recession is a foregone conclusion and the only questions are how long and how deep. The BOE sees recession starting in Q4 and lasting five quarters but that is simply their best guess right now.
Despite the gloomy macro forecasts, the BOE is set to continue tightening as inflation spirals ever higher. WIRP suggests a 25 bp hike September 15 is fully priced in, with 60% odds of a larger 50 bp move. The swaps market is pricing in 125-150 bp of tightening over the next 6 months that would see the policy rate peak between 3.0-3.25%, up from 2.75% at the start of last week.
Eurozone has a quiet week. June IP will be reported Friday and is expected at 0.2% m/m vs. 0.8% in May. Last week’s country-level IP data were mixed. However, the overarching story for the eurozone is one of weakness and likely recession. ECB tightening expectations continue to go up and down from week to week. WIRP suggests a 50 bp hike is 85% priced in for September 8. The swaps market is pricing in 125-150 bp of tightening over the next 12 months that would see the deposit rate peak between 1.25-1.5%, up from 125 bp at the start of last week.
Norway reports July CPI Wednesday. Headline is expected at 6.4% y/y vs. 6.3% in June, while underlying is expected at 3.8% y/y vs. 3.6% in June. At the last policy meeting June 23, Norges bank hiked 50 bp to 1.25% vs. 25 bp expected. It warned that “In the Committee’s assessment, a markedly higher policy rate is needed to stabilize inflation around the target. Given a tight labor market, employment will likely remain high even with a higher policy rate ahead.” It also flagged a likely 25 bp hike to 1.5% at the next meeting August 18. The new June rate path suggests a steeper tightening cycle ahead as the bank now sees the policy rate peaking near 3.1% in 2024 vs. 2.5% previously. This is more aggressive than the market, as the swaps market is pricing in 100 bp of tightening over the next 12 months that would see the policy rate peak near 2.25%.
Sweden reports July CPI Friday. Headline is expected to remain steady at 8.7%, CPIF is expected at 8.2% y/y vs. 8.5% in June, and CPIF ex-energy is expected at 6.6% y/y vs. 6.1% in June. The Riksbank meets September 20 and another hike is likely. At the last meeting June 30, the Riksbank hiked 50 bp to 0.75%, as expected. Governor Ingves said that if it becomes necessary, the bank will hike by 75 bp but added “At this point our basic assumption is that hiking the rate to somewhere around 2%” will be enough and stressed “if that isn’t enough we will continue increasing the policy rate further until we get inflation down to our target.” The swaps market has a different view and is pricing in 175 bp of tightening over the next 12 months that would see the policy rate peak near 2.5%. If inflation remains high, the Riksbank’s expected rate path should move even closer to market pricing.
ASIA
Japan reported June current account data. The adjusted balance came in at JPY838 bln vs. -JPY28 bln expected and JPY8 bln in May. However, the investment flows will be of most interest. Data showed that Japan investors were net sellers of U.S. bonds for the eighth straight month and the -JPY3.72 trln total was the biggest since April 2020. Japan investors were small net buyers (JPY8 bln) of Australian bonds and were net sellers of Canadian bonds (-JPY337 bln) for the fifth straight month. They were small net sellers of Italian bonds (-JPY32 bln) for the second straight month. Otherwise, Japan has a quiet week. July machine tool orders will be reported Tuesday. July PPI will be reported Wednesday and is expected at 8.4% y/y vs. 9.2% in June. If so, it would be the third straight month of deceleration from the 9.9% peak in April and suggests that price pressures may be topping out. In turn, this would support the Bank of Japan’s decision to maintain its ultra-dovish stance for the time being.
