We are not yet ready to change our strong dollar call. Yes, the U.S. economic data have been weakening but we do not think a recession is imminent. U.S rates have fallen sharply but this is not limited to the U.S. as weak data out of the eurozone have also led markets to reassess ECB tightening expectations. When all is said and done, we believe the U.S. economy remains the most resilient. However, we expect a period of consolidation ahead for the dollar until the economic outlook becomes clearer.
AMERICAS
The U.S. rates market continues to price in doom and gloom ahead of the FOMC decision. The 10-year yield ended last week near 2.75% after trading as low as 2.73%, the lowest since May 27 and nearing the May 26 low near 2.70%, while the 2-year yield ended last week near 2.97% after trading as low as 2.90%, the lowest since July 5 and nearing the July 1 low near 2.73%. While we believe some signs of improvement in inflation are emerging, most measures remain elevated and so the Fed is likely to continue tightening policy in H2.
Curve flattening has intensified as U.S. data have started to weaken noticeably. The 2- to 10-year curve has fallen to a cycle low -22 bp. Faithful readers know that we prefer to look at the 3-month to 10-year curve but that too is moving in a worrisome manner. At 37 bp, it is the flattest since March 2020 and is moving closer and closer to inversion. The speed of flattening has been nothing short of astounding, as it stood at 139 bp at the start of July and was 185 bp in mid-June.
The two-day FOMC ends Wednesday and the Fed is widely expected to hike rates 75 bp to 2.50%. WIRP suggests only 10% odds of a 100 bp move. Updated macro forecasts and Dot Plots won’t come until the September meeting. Another 75 bp hike September 21 is only about 45% priced in, with a 50 bp move favored then. A 25 bp hike is priced in for November 2 but after that, one last 25 bp hike is only partially priced in. The swaps market paints a similar picture, with 175 of tightening priced in over the next 6 months that would see the policy rate peak near 3.5%. Then, an easing cycle is priced in for the subsequent 6 months.
June core PCE data Friday will be important. It is expected to remain steady at 4.7% y/y after three straight months of deceleration from the 5.3% peak in February. Still, it is nowhere close to the Fed’s 2% target. Personal income and spending will be reported at the same time and are expected at 0.5% m/m and 0.9% m/m, respectively.
June Chicago Fed National Activity Index will be reported Monday. It is expected at -0.03 vs. a revised -0.19 in May. If so, the 3-month moving average would fall to 0.01 vs. a revised 0.09 in May. This would be the lowest since February 2021 but still well above the -0.7 threshold that signals imminent recession. Obviously, the slowdown is concerning and we need to keep an eye on this data series, as well as the U.S. yield curve.
Regional Fed manufacturing surveys for July will continue rolling out. Dallas Fed reports Monday and is expected at -22.0 vs. -17.7 in June. Richmond reports Tuesday and is expected at -17 vs. -11 in June. Kansas City wraps things up Thursday and is expected at 4 vs. 12 in June. So far, Philly Fed came in at -12.3 vs. -3.3 in June and the Empire survey came in at 11.1 vs. -1.2 in June. Elsewhere, Chicago PMI will be reported Friday and is expected to remain steady at 56.0. Last week, preliminary July S&P Global PMI readings for the U.S. came in much weaker than expected as the composite fell to 47.5, the lowest since May 2020 and drive mostly by a drop in services to 47.0. As such, there are clearly downside risks to this week’s survey data.
We get our first look at Q2 GDP Thursday. Consensus sees growth at 0.5% SAAR vs. -1.6% in Q1. Note that the Atlanta Fed’s GDPNow model is tracking -1.6% SAAR and so markets are likely braced for a downside miss. The final Q2 update will be Wednesday and will be followed by the initial Q3 estimate Friday. Of note, Bloomberg consensus for Q3 is currently 1.7% SAAR.
Other minor data reports will round out the week. May FHFA and S&P CoreLogic house price indexes will be reported Tuesday. July Conference Board consumer confidence (96.9 expected) and June new homes sales (-5.0% m/m expected) will also be reported Tuesday. June advance goods (-$103.0 bln expected), wholesale and retail inventories, durable goods orders (-0.3% m/m expected), and pending home sales (-1.0% m/m expected) will be reported Wednesday. Weekly jobless claims will be reported Thursday. Q2 employment cost index and final July University of Michigan consumer sentiment will be reported Friday.
EUROPE/MIDDLE EAST/AFRICA
Markets are still digesting last week’s ECB decision. WIRP suggests 50 bp hikes are now pretty much priced in for the next meetings September 8 and October 27, followed by a 25 bp hike December. Looking ahead, the swaps market is now pricing in 175 bp of tightening over the next 24 months that would see the deposit rate peak near 1.75%, with some odds seen of another 25 bp hike thereafter.
July CPI readings will be very important. Germany reports Thursday. EU Harmonized CPI is expected to fall a tick to 8.1% y/y. France and Spain report early Friday. Their EU Harmonized CPI readings are expected at 6.7% y/y and 10.5% y/y, respectively, and both would be higher than June. Later that day, the eurozone and Italian readings will be reported. Italy’s EU Harmonized CPI is expected to rise two ticks to 8.7% y/y. For the eurozone as a whole headline is expected to pick up a tick to 8.7% y/y, while core is expected to pick up two ticks to 3.9% y/y. Eurozone M3 data for June will be reported Wednesday and is expected to slow two ticks to 5.4% y/y.
Eurozone Q2 GDP data Friday will also be important. Q/q growth is expected at 0.2% vs 0.6% in Q1, while y/y growth is expected at 3.4% vs. 5.4% in Q1. Germany is expected to be the weak link at 0.1% q/q and 1.8% y/y. France is expected at 0.2% q/q and 3.7% y/y, Italy is expected at 0.3% q/q and 3.7% y/y, and Spain is expected at 0.4% q/q and 5.6% y/y. The preliminary July PMI readings last week suggest Germany is already tipping into recession. German IFO business climate survey for July will be reported Monday. Headline is expected at 90.1 vs. 92.3 in June, with both current assessment and expectations falling to 97.5 and 83.0, respectively. GfK consumer confidence for August will be reported Wednesday and is expected at -28.9 vs. -27.4 in July.
U.K. has a quiet week. CBI releases the results of its July surveys. Industrial trends survey will be reported Monday, with total orders expected at 13 vs. 18 in June and selling prices expected at 55 vs. 58 in June. Distributive trades survey will be reported Tuesday, with retailing reported sales expected at -10 vs. -5 in June. June consumer credit, mortgage approvals, and money supply will all be reported Friday.
Bank of England expectations remain subdued. WIRP suggests a 50 bp hike move at the August 4 meeting is now only around 80% priced in; at the start of last week, it was fully priced in. Similarly, 50 bp hikes are no longer fully priced in for the subsequent meetings September 15 and November 3, while a 25 bp hike December 15 remains fully priced in. Looking ahead, the swaps market is still pricing in 175 bp of tightening over the next 6 months that would see the policy rate peak near 3.0%.
ASIA
Japan reports some key data. June department store sales will be reported Monday July Tokyo CPI will be reported Friday. Headline is expected to pick up a tick to 2.4% y/y, core (ex-fresh food) is expected to pick up a tick to 2.2% y/y, and core ex-energy is expected to pick up a tick to 1.1% y/y. June labor market data, retail sales, and IP will also be reported Friday. Unemployment is expected to fall a tick to 2.5%, sales are expected at 0.2% m/m vs. 0.7% in May, and IP is expected at 4.1% m/m vs. -7.5% in May. Recent Japan data will be seen as vindication by the BOJ in terms of its loose policy stance; the economy remains sluggish but inflation remains under control. The swaps market is basically pricing in steady policy for the next 36 months, with very small odds of liftoff seen towards the end of that period.
Australia highlight will be Q2 CPI data Wednesday. Headline is expected at 6.3% y/y vs. 5.1% in Q1, while trimmed mean is expected at 4.7% y/y vs. 3.7% in Q1. If so, headline would be the highest since Q4 90 and further above the 2-3% target range. WIRP suggests 50 bp hikes August 2 and September 6 are fully priced in, but are only about 50% priced in for October 4 and November 1. The swaps market is pricing in 225 bp of tightening over the next 6 months that would see the policy rate peak near 3.6%, down from nearly 4.5% over the next 12 months that was priced in at the start of this month. If the economy continues to weaken, markets will have to reassess this expected terminal rate. June retail sales will be reported Thursday and are expected to rise 0.4% m/m vs. 0.9% in May. Q2 PPI and June private sector credit data will be reported Friday.
