Euro Firm as Eurozone Inflation Spikes

August 31, 2021
  • The dollar remains under pressure as real yields fall; August Chicago PMI will be the data highlight; Fed manufacturing surveys for August wrapped up yesterday with Dallas reporting; Banco de Mexico releases its quarterly inflation report
  • Eurozone inflation readings for August came in higher than expected; details of ECB asset purchases for the week ending August 27 will be reported; France reported weak July consumer spending; Poland August CPI came in at 5.4% y/y, the highest level in two decades
  • Japan reported surprisingly firm July data; official China PMI readings were much weaker than expected

The virus news stream is largely positive today. New Zealand Prime Minister Ardern said that lockdown conditions will be partially eased in Auckland, leading to a nearly 1% rally in the Kiwi vs the dollar. Similarly, news of easing mobility restrictions in several regions of Indonesia led IDR to the strongest level since mid-June. Separately, Brazil has now surpassed the U.S. in the share of population that has received a single dose of Covid vaccine. Elsewhere Oil declined as OPEC committed to raising supply limits while Treasuries continued to fall, 10yr to 1.27%. The US completed its withdrawal from Afghanistan while hurricane Ida was downgraded to a tropical depression as it moved inland, and Australia’s latest virus outbreak worsened.

The dollar is under pressure again. DXY is down for the third straight day and trading at the lowest level since August 6. Clean break below 92.526 sets up a test of the July 30 low near 91.782. The euro is leading this move on higher than expected CPI data (see below) and is well on its way to test the July 30 high near $1.1910. Sterling continues to lag and so far has been unable to break above $1.38, pushing the EUR/GBP cross higher to new highs for this move near .8600. USD/JPY remains heavy below 110 and a break of 109.70 and then 109.55 is needed to set up a test of the August 16 low near 109.10. We remain positive on the dollar but acknowledge that stronger U.S. data this week is needed to offset the impact of Powell’s speech.


The dollar remains under pressure as real yields fall. The 10-year real yield has dropped nearly 10 bp since Powell's speech to -1.08%, the lowest since August 16. This is due to the combination of the 10-year nominal yield falling 7 bp and the 10-year breakeven inflation rate rising 2 bp. If the breakeven rate continues to rise, we think that is basically the market telling Powell that his rather dovish stance implies higher inflation risks ahead. This is worth keeping an eye on this as we get more economic data this week. At the very least, it will take some very strong U.S. data to turn things around near-term. Even that is not a guarantee, though Bostic and Daly speak tomorrow and are likely to deliver some hawkish comments.

August Chicago PMI will be the data highlight today. It is expected at 68.0 vs. 73.4 in August. August ISM manufacturing PMI will be reported tomorrow and is expected at 58.5 vs. 59.5 in July. ISM services PMI will be reported Friday and is expected at 61.7 vs. 64.1 in July. Of note, Markit preliminary manufacturing PMI came in at 61.2 vs. 63.4 in July, services came in at 55.2 vs. 59.9 in July, and the composite came in at 55.4 vs. 59.9 in July. June S&P CoreLogic house prices and August Conference Board consumer confidence (123.0 expected) will also be reported. Elsewhere, Canada reports Q2 GDP, with growth expected at 2.5% q/q annualized 5.6% in Q1.

Fed manufacturing surveys for August wrapped up yesterday with Dallas reporting. It came in at 9.0 vs. 23.0 expected and 27.3 in July. All told, Kansas City Fed came in at 29 vs. 30 in July, Richmond Fed came in at 9 vs. 27 in July, Empire survey came in at 18.3 vs. 43.0 in July, and Philly Fed came in at 19.4 vs. 21.9 in July. Virtually all the survey and PMI readings were at or near record highs this summer and so some moderation is to be expected from these lofty levels. This does not mean the manufacturing sector is slowing sharply.

Banco de Mexico releases its quarterly inflation report. Despite delivering two hikes in a row, it’s not clear how much more tightening the bank is willing to deliver. Minutes from the August 12 meeting showed one board member who voted to hike rates 25 bp to 4.5% said that no more hikes may be needed for now. The official added that future decisions would be data dependent and that the August hike didn’t imply an aggressive tightening cycle was under way. Since that vote was a split 3-2, this suggests the bank may remain on hold at the next policy meeting is September 30, depending on the data.


Eurozone inflation readings for August came in higher than expected. France and Italy came in at 2.4% y/y and 2.6% y/y, respectively, both up sharply from July. This helped push the headline eurozone reading up to 3.0% y/y vs. 2.7% expected and 2.2% in July, the highest since 2011. Core rose 1.6% y/y vs. 1.5% expected and 0.7% in July. Eurozone PPI will be reported Thursday and is expected to accelerate to 11.0% y/y vs. 10.2% in June, suggesting further upside risks to CPI ahead. The party line remains that this spike is transitory and while we expect the hawks will be very nervous, the doves remain in the driver’s seat. There have been some hints of potential smaller ECB asset purchases (see below) that bear watching, but we do not think the needle has moved much on its monetary stance relative to the Fed.

Details of ECB asset purchases for the week ending August 27 will be reported. Net purchases were reported yesterday at only EUR11.5 bln vs. EUR16.6 bln for the week ending August 20 and EUR17.2 bln for the week ending August 13. The ECB has been aiming for net weekly purchases of around EUR20 bln since the accelerated pace began in March, but have fallen a bit short due to thin market conditions over the summer. ECB Governing Council member Villeroy said recently that “On monthly volumes, we are looking at the favorable financing conditions, and we should underline that they are more favorable than at our June meeting. We have to decide the monthly volumes for the fourth quarter.” Chief Economist Lane also hinted at adjusting its purchases, noting that "You cannot think about the volume of the APP independently of the volume of net bond supply." While the bank has said it will discuss changes to its asset purchases at the next meeting September 9, we do not think a consensus will be reached until the December 16 meeting.

France reported weak July consumer spending. It was expected to rise 0.2% m/m but instead fell -2.2% m/m vs. a 0.3% gain in June. Germany reports July retail sales tomorrow and they are expected at -1.0% m/m vs. 4.5% in June. Eurozone retail sales for July will be reported Friday and are expected flat m/m vs. 1.5% in June. Obviously, the French reading warns of downside risks ahead for eurozone consumption.

Poland August CPI came in at 5.4% y/y, the highest level in two decades and much higher than the 5.1% expected. This leaves the central bank in an even more isolated position in comparison to other regional banks such as Hungary, Czech, and Russia. We think this posture will change soon but for now, officials continue to uphold the view that inflationary factors are temporary and don’t warrant a policy reaction yet. Yields are up about 4 bp across the curve and the zloty is outperforming as investors start to reprice the risk of tightening sooner rather than later.


Japan reported surprisingly firm July data. Unemployment fell a tick to 2.8% vs. expectations it would remain steady at 2.9%, while the jobs-to-applicant ratio rose two ticks to 1.15 rather than the expected drop to 1.12. Elsewhere, IP fell -1.5% m/m vs. -2.5% expected and housing starts rose 9.9% y/y, nearly double the expected 5.3%. Yesterday, retail sales came in stronger than expected. The strength in the economy as Q3 got under way is surprising given the ongoing state of emergency. We suspect the strength won’t be sustained but either way, we fully expect the Suga government to unveil a fiscal package soon to give the economy a boost ahead of fall elections.

Official China PMI readings were much weaker than expected. China’s official August non-manufacturing PMI fell into contractionary territory at 47.5 vs 52.0 expected and 53.3 in July. This means China’s services sector contracted for the first time since March 2020, suggesting the impact of the new various strain has been underestimated. The manufacturing component came in at 50.1, close to expectations and down from 50.4 in July, but the composite dropped from 52.4 to 48.9. Caixin reports its manufacturing PMI tomorrow, which is expected at 50.1 vs. 50.3 in July. This will be followed by its services and composite PMIs Friday, with services expected at 52.0 vs. 54.9 in July. Both are clearly subject to downside risks. The data will serve to reinforce the PBOC’s gentle easing bias with further cuts to reserve requirements even more likely. This news saw equities across the APAC sector close lower despite another record high on Wall Street on Monday, with equities in Chinas CSI 300 -0.4%.

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