US
USD extended yesterday’s upswing underpinned by widening US-G6 two-year bond yield spreads. Favorable US economic activity and a stable labor market will keep Fed rate hike expectations firmly in play in the near-term. But we don’t expect USD to make new cyclical highs because tightening by other major central banks limits monetary policy divergence.
Brent crude oil prices rose briefly to near a five-week high at $97 a barrel as the US-Iran conflict intensified. Further upside appears limited as Persian Gulf oil exports recover. Goldman Sachs estimates oil flows from the region have returned to roughly two-thirds of their pre-war level of 20 million barrel per day. That broadly aligns with the US Energy Secretary’s estimate that on average 8 million barrels a day are passing through the Strait of Hormuz, while another 4 to 5 million barrels are bypassing it through pipelines.
The global bond market rout deepened reflecting firmer crude oil prices and a resilient global growth outlook. Aside from the UK and Japan, the bond market selloff is not worrisome as 10-year bond government yields for most major economies are still trading below nominal GDP growth.
US August ADP private payrolls is up next (1:15pm London, 8:15am New York). Consensus is for the economy to add +47k jobs vs. +44k in July. The Fed Beige Book (7:00pm London, 2:00pm New York) will offer fresh anecdotal insights into the US growth and inflation outlook.
US manufacturing sector growth momentum eased more than expected in August, but price pressures persist. The headline index dipped to a two-month low at 54.6 (consensus: 55.2) vs. 55.6 in July driven by slower expansions in both the New Orders and Employment indexes. The Prices Paid index held at 71.1 (consensus: 70.8) for a second straight month signaling ongoing upside inflation risks.
The JOLTS July survey reinforced the US labor market’s low hire, low fire backdrop. The hiring rate fell -0.2ppt to 3.2%, lowest since February. The layoffs rate dipped -0.1ppt to 1.0%, remaining within its 1.0-1.2% range that’s held for the past two years.
CANADA
USD/CAD is gaining ground and closing in on resistance at 1.4000. The Bank of Canada (BOC) is widely expected to keep the policy rate on hold at 2.25% for a seventh consecutive meeting (2:45pm London, 9:45am New York). The worsening US-Canada trade war threatens to derail Canada’s Q2 growth pick-up. Encouragingly, core inflation near 2% gives the BOC room to stand pat and cushion economic activity.
As such, market pricing 75bps of BOC hikes in the next twelve months look too aggressive, leaving scope for a dovish repricing and USD/CAD vulnerable to an overshoot of 1.4000. Remember, the BOC highlighted at its April 29 meeting, that “if the United States imposes significant new trade restrictions on Canada, we may need to cut the policy rate further to support economic growth.”
Nevertheless, Canada’s favorable labor market condition argues against a rate cut. Canada’s August labor force survey is due on Friday, and the economy is expected to add +15.0k jobs vs. +75.1k in July with the unemployment rate holding at a two-year low of 6.4%.
NEW ZEALAND
NZD underperformed across the board after the RBNZ delivered a dovish hike. As was widely expected, the RBNZ raised the Official Cash Rate (OCR) for a second straight time by 25bps to 2.75%. However, the RBNZ cautioned that “this decision reduces the risk that the OCR needs to increase by more later.”
Indeed, the RBNZ stressed that “spare capacity remains in the economy, particularly in the labour market.” The RBNZ also left its OCR path virtually unchanged from May, still projecting a peak of around 3.25% in 2028. In contrast, the swaps curve implies the OCR at 4.00% in the next two years. This gap leaves ample room for a dovish repricing which is a drag on NZD.
AUSTRALIA
AUD/USD dropped to a multi-day low near 0.7125 on broad USD strength. Australia Q2 real GDP growth overshot expectations. The economy increased 0.4% q/q (consensus: 0.3%) vs. 0.3% in Q1 to be up 2.1% y/y which is above the RBA’s forecast of 1.9% y/y. The details were good and points to resilient consumer spending activity. Household spending made the largest contribution to Q2 GDP growth (+0.2ppt) driven by vehicle purchases.
RBA cash rate futures raised bets for additional hikes after the GDP release. Odds of a 25bps hike on September 29 jumped from 55% to nearly 80%, while markets moved closer to pricing 50bps of tightening over the next twelve months. Bottom line: Australia’s attractive carry alongside the country’s strategic exposure to commodities linked to energy, AI, and defense remain key AUD tailwinds.
JAPAN
USD/JPY continue to test psychological resistance at 160.00. Hawkish Bank of Japan (BOJ) comments offered JPY brief support overnight. Staunch hawk Takata Hajime left the door open for a 50bps or 75bps hike on September 18 and back-to-back rate hikes. In parallel, Governor Kazuo Ueda reiterated the need “to pay greater attention than before to upside risks” to inflation.
A jumbo BOJ hike at the next meeting is a real possibility, as inflation expectations account for most of the rise in 10-year JGB yields. A forceful move could ultimately cap the long end of the yield curve by anchoring inflation expectations and support JPY. The swaps curve price in just 5% odds of a 50bps hike on September 18.
