US
USD recouped some of yesterday’s losses against most major currencies. SEK bucked the broad USD move as Sweden’s mixed July CPI kept a Riksbank hike by year-end firmly in play. Brent crude is holding just below $80 per barrel after a provisional Iran-Oman agreement raised the prospect of more energy flows resuming through the Strait of Hormuz.
The drag to USD from the Fed’s credibility gap has eased. US 5y5y inflation swaps have retraced much of the rise triggered by Fed Chair Kevin Warsh’s failure to turn tough inflation rhetoric into credible policy. Comments from some Fed officials may have helped steady the ship.
Fed Governor Lisa Cook stressed “If I do not see signs of continued disinflation soon, I am prepared to act [raise rates].” Similarly, San Francisco Fed President Mary Daly (2027 FOMC voter) cautioned that price increases from tariffs, higher energy costs and continued AI investment could become more entrenched, requiring more aggressive action from the Fed.
Nonetheless, USD relief rallies are likely to remain shallow. USD is trading in line with interest rate differentials, and we see limited scope for a more hawkish repricing in Fed funds rate expectations. The US labor market is in balance, wage growth is consistent with the Fed’s 2% inflation target, and Fed policy is restrictive, assuming a neutral rate of 3.00%.
The US July ISM surveys released this week sent contrasting signals and puts the Fed in a tough spot. The ISM Services data showed resilient demand, employment contracting and inflation heating up. The ISM Manufacturing print showed broad-based strength, with demand and employment firming, while prices pressures eased slightly.
Given that services accounts more a much larger share of the US economy (around 80%), weaker services hiring argues for Fed patience, but the renewed pick-up in services price pressure suggests upside inflation risks have yet to fully recede. That raises the cost of waiting to raise rates, with the Fed increasingly at risk of falling behind the curve. Fed funds futures continue to imply about 60% probability of a September rate hike.
More encouraging for the Fed is the disinflationary force from strong US productivity growth. The Employment Cost Index (ECI) wages & salaries - the Fed’s favorite wage data – was 3.2% y/y in Q2, consistent with the Fed’s 2% target given average annual labor productivity growth of 2.1%. Q2 non-farm productivity report is due today (1:30pm London, 8:30am New York). Continued annual productivity growth around 2% can further absorb wage gains without generating additional inflation pressure.
Revelio Labs non-farm employment is also in the pipeline today (1:30pm London, 8:30am New York). There is no consensus estimate for Revelio Labs employment, but in June it showed the economy added +258.8k jobs. According to Revelio Labs, its employment data has a 0.74 correlation coefficient with the non-farm payrolls survey.
SWEDEN
SEK is outperforming. Sweden’s mixed July CPI keeps a Riksbank hike in play. CPIF printed at 0.7% y/y vs. 1.3% in June, which was in line with consensus but above the Riksbank’s forecast of 0.5%. CPIF ex-energy ran hotter than expected at 0.6% y/y (consensus: 0.3%, Riksbank forecast: 0.2%) vs. 0.4% in June.
While inflation in Sweden is well below its 2% target, the Riksbank signaled in June that “the probability that the rate will be raised later this year has increased.” The swaps curve continues to more than fully price in a 25bps hike to 2.00% in December which is SEK supportive.
BRAZIL
As was widely expected, Banco Central do Bazil (BCB) delivered a fourth straight 25bps cut to 14.00%. BCB has room to remove policy restrictiveness as the policy rate is well above the bank’s estimate of the neutral rate (8%, or 5% in real terms). Brazil’s strategic exposure to commodities linked to energy, AI, and defense will continue to bode well for BRL. BRL is the top performing major currency so far this year, up nearly 8% versus USD.
