The dollar continues to gain. Friday’s relief rally was fueled by the notion that the Fed would hike rates “only” 75 bp this month rather than 100 bp. That said, recent data suggest the Fed still has a long ways to go in terms of tightening. Contrast this iwth the rest of the world, where many countries are struggling to avoid recession. From a relative value standpoint, the dollar remains king.
AMERICAS
Markets are still digesting the inflation data for June. Headline inflation came in at 9.1% y/y vs. 8.8% expected and 8.6% in May. The only ray of hope was that core inflation decelerated for the third straight month to 5.9% y/y, the lowest since December. This suggests that the Fed’s preferred measure core PCE may do the same. That said, the Fed realizes that headline is what really counts for the average household and so the aggressive tightening cycle will continue. Period.
Fed tightening expectations have picked up. WIRP suggests a 75 bp hike at the next meeting July 27 is now fully priced in, with 70% odds of a 100 bp move. A 75 bp hike September 21 is now also fully priced in, followed by 25 bp November 2. One last 25 bp hike December 14 is about 50% priced in, which would take the Fed Funds ceiling up to 3.75%. Of note, WIRP then suggests the beginning of an easing cycle by Q1 23. Similarly, the swaps market is now pricing in 200 bp of tightening over the next 6 months that would see the policy rate peak near 3.75%, followed by the start of an easing cycle over the subsequent 6 months. This is a much earlier timeframe for easing and one that we think is very, very premature since it would imply a recession hitting the U.S. near the end of this year or early next year.
As of midnight last Friday, the Fed’s media blackout went into effect. There will be no more Fed speakers until Chair Powell’s post-decision press conference July 27. Ahead of the blackout last week, Fed officials implied that nothing was off the table after the CPI report. Bostic said “everything is in play” while Mester said there was no reason for a smaller hike. Daly said 75 bp was her “most likely posture.” Of note, the Fed’s Beige Book released last week noted that price increases remained “substantial” across the nation in recent weeks, though some regions saw signs of cooling inflation.
The slope of the U.S. yield curve is getting more concerning. Faithful readers will know that we focus on the 3-month to 10-year curve, which until very recently was quite steep. As recently as early June, this curve was near 185 bp but has since fallen to 67 bp, the flattest since October 2020. Yes, the 2- to 10-year curve has already inverted and we acknowledge that the 3-month to 10-year curve may follow it into inversion. However, it is not a sure thing.
Housing data take center stage this week. July NAHB housing market index will be reported Monday. June building permits and housing starts will be reported Tuesday. Existing home sales will be reported Wednesday.
Regional Fed manufacturing surveys for July will continuing rolling out. Philly Fed reports Thursday and is expected at 1.7 vs. -3.3 in June. Last week, the Empire survey came in at 11.1 vs. -1.2 in June. S&P Global also reports its preliminary July PMI readings Friday. Manufacturing is expected at 51.0 vs. 52.7 in June, while services is expected at 52.0 vs. 52.7 in June. If so, the composite PMI would fall sharply from 52.3 in June.
Canada highlight will be June CPI data Wednesday. May retail sales Friday will also be important. The Bank of Canada surprised markets with a 100 bp hike to 2.5% last week vs. 75 bp expected. WIRP suggests a 75 bp hike to 3.25% is nearly 75% priced in. Looking ahead, the swaps market is pricing in 125 bp of tightening over the next 6 months that would see the policy rate peak near 3.75%. Similar to what’s priced in for the Fed, the swaps market sees the BOC starting an easing cycle over the subsequent 6 months.
EUROPE/MIDDLE EAST/AFRICA
The European Central Bank is meets Thursday and is expected to hike rates 25 bp. Despite some hawks calling for a 50 bp hike, it seems clear that the bank will opt for a more cautious move. Updated macro forecasts won’t be released until the September 8 meeting. As usual, Madame Lagarde’s press conference is likely to provide the fireworks, whether good or bad. We know that the divide between the hawks and doves remains wide. A 50 bp hike is fully priced in for the next meeting September 8, with some odds seen of a 75 bp move. Expected moves at the subsequent meetings October 27 (50 bp) and December 15 (25 bp) would see the deposit rate near 1.0% at year-end. Looking ahead, the swaps market is now pricing in 200 bp of tightening over the next 12 months that would see the deposit rate peak near 1.5%.
The ECB is also expected to reveal some more details about its new anti-crisis tool. As always, we are braced for disappointment but perhaps the ECB will surprise us. As things stand, it’s very apparent that there is the usual split between the debtor and creditor nations. Bundesbank President Nagel has made it clear that the creditors remain reluctant to write a blank check to the debtors. As a result, it seems likely that the Governing Council will be unable to agree on the trigger and conditionality for the planned anti-crisis tool.
Preliminary eurozone July PMI readings will be reported Friday. Manufacturing is expected at 51.0 vs. 52.1 in June, services is expected at 52.0 vs. 53.0 in June, and the composite PMI is expected at 51.0 vs. 52.0 in June. Looking at the country breakdown, the German composite is expected at 50.4 vs. 51.3 in June and the French composite is expected at 51.1 vs. 52.5 in June. Italy and Spain will be reported with the final PMI readings out in early August.
Italian politics remain in flux. Prime Minister Draghi offered his resignation last week after the Five Star Movement boycotted a confidence vote in the Senate that was tied to an economic package meant to help households and businesses cope with higher inflation. He said “The loyalty agreement that was the foundation of my government has gone missing. The majority of national unity that backed this government since it was set up is not there anymore.” Conte’s Five Star Movement is the second-largest group in parliament but has seen its support plunge in recent months. If push comes to shove, we suspect it will try to avoid snap elections. President Mattarella turned down Draghi’s resignation. He could eventually call for a confidence vote that is not tied to any particular bill.
The monthly U.K. data dump continues. Labor market data will be reported Tuesday. June CPI data will be reported Wednesday. Public sector net borrowing will be reported Thursday. Retail sales will be reported Friday. Preliminary July PMI readings will also be reported Friday. Manufacturing is expected at 52.0 vs. 52.8 in June, services is expected at 54.0 vs. 54.3 in June, and the composite PMI is expected at 52.5 vs. 53.7 in June.
Bank of England expectations have eased as the headwinds pile up. WIRP suggests a 50 bp hike move at the August 4 meeting is fully priced in. 50 bp hikes are priced in for the subsequent meetings September 15 and November 3, followed by 25 bp December 15. Looking ahead, the swaps market is pricing in 175 bp of tightening over the next 6 months that would see the policy rate peak near 3.0%.
The U.K. political outlook appears to be solidifying. After the second round vote for the Tory leadership, Sunak and Mordaunt are emerging as the frontrunners with 101 and 83 votes, respectively. Truss came in third with 64, while Braverman and Badenoch were knocked out. Polls suggest Mordaunt would beat all the contenders in head to head match ups, while Truss is surely disappointed by her third place standing. There will be lots of horse-trading in the coming days and so the situation is very fluid. The third round will be held Monday, while the final two candidates should be in place by Thursday. Parliament then goes on summer recess, the final two make their case to Tory members over the subsequent six weeks, and the winner will be announced September 5.
ASIA
The two-day Bank of Japan meeting ends Thursday with a decision. No change is expected for any of the bank’s policy settings. Updated macro forecasts will be released but are unlikely to signal any shift from its current ultra-dovish stance. The weak yen is likely to get a mention of concern but the pace of weakening has slowed in recent weeks. USD/JPY rose nearly 6% in March, nearly 7% in April, fell 1% in May, and rose 5.5% in June. So far in July, the pair has risen about 2%. In FX, it’s typically more about the pace than any particular level. That said, once we get to the psychological 140 level, there is not much until the August 1998 high near 147.65.
Japan also reports some key data. June trade data and machine tool orders will be reported Thursday. June national CPI data will be reported Friday. Headline is expected to fall a tick to 2.4% y/y, while core (ex-fresh food) is expected to pick up a tick to 2.2% y/y. Core ex-energy is expected to pick up a tick to 0.9% y/y. Preliminary July PMI readings will also be reported Friday.
New Zealand reports Q2 CPI Monday. Headline is expected at 7.1% y/y vs. 6.9% in Q1. If so, it would be the highest since Q2 90 and further above the 1-3% target range. Reserve Bank of New Zealand just hiked rates last week 50 bp to 2.50% and said “The Committee agreed to maintain its approach of briskly lifting the OCR until it is confident that monetary conditions are sufficient to constrain inflation expectations and bring consumer price inflation to within the target range.” WIRP suggests a 100 bp hike August 17 is about 60% priced in. The swaps market is pricing in 150 bp of tightening over the next 6 months that would see the policy rate peak near 4.0% followed by steady rates over the subsequent 6 months. The start of an easing cycle would be some time over the following 12 months.
Reserve Bank of Australia minutes will be released Tuesday. At that meeting, it hiked rates 50 bp to 1.35%. Updated macro forecasts won’t come until the August 2 meeting, but it’s worth noting that last week’s jobs report came in much stronger than expected, with the unemployment rate falling to a record low 3.5%. WIRP suggests a 50 bp hike is fully priced in for next month, followed by another 50 bp hike September 6. The swaps market is pricing in over 200 bp of tightening over the next 12 months that would see the policy rate peak near 3.5%. Preliminary July PMI readings will be reported Friday.
