TERADAT SANTIVIVUT
In the middle of last week, the Fed funds futures discounted 103 bp of cuts this year. There was some movement, but after Fed Chair Powell’s speech, the market finished the week with 104 bp of cuts priced into the Fed funds futures curve. The two-year note yield settled at a three-week low and the dollar slumped. The Dollar Index lost 1.7% last week, its fifth consecutive drop and the largest weekly decline of the year. Although the euro rose to $1.12, its best level since July 2023, and sterling appreciated to $1.3230, its best level since March 2022, they did not lead the assault on the greenback. Rather, the New Zealand dollar (~2.85%) and the Swedish krona (~2.6%) took charge. The swaps market has three cuts fully discounted for the remainder of the year for their respective central banks. The central banks for the UK, Australia, and Norway are most unlikely to cut next month, but their currencies were middle performers last week. The Bank of Japan still appears on track to hike rates at the end of the year, barring new market turmoil.
In the week ahead, the Fed’s targeted measure of inflation, the headline PCE deflator, the eurozone’s preliminary August CPI, Tokyo’s August CPI, and Australia’s monthly print for July are the highlights. While there is headline risk, and although the central bank says that they are data-dependent, we suspect without a significant surprise, rate cut expectations will be largely unimpacted by the data. Instead, the pressing issue is that the rates market has an extremely aggressive Fed easing discounted, and the dollar is oversold. The next batch of key data that could show that the loss of jobs and rise in unemployment in July was a bit exaggerated. Job growth may have improved sequentially, and the unemployment rate may have dipped. The August CPI will be reported on September 11, a week ahead of the FOMC meeting. The core rate may have edged up.
United States
We are in between Jackson Hole and the September 6 jobs report. Economists are still adjusting Q3 GDP forecasts. It is still early in the data cycle for the Atlanta Fed’s GDP tracker, which now stands at 2.0%, while the median forecast in Bloomberg’s survey is for 1.5% growth. This week’s report of durable goods orders (a recovery of nearly 4% is expected after a 6.7% drop in June). The headline will be flattered by a jump in Boeing orders from 14 in June to 72 in July. Excluding transportation orders, durable goods orders may have slipped by 0.1% after rising by 0.4% in June. Personal consumption expenditure also will impact GDP forecasts, and the better-than-expected retail sales report suggests a somewhat larger gain than June’s 0.3% rise. Income growth may have held steady at 0.2%. Until recently, the deflator captured the market’s attention as the Fed understood that the risks to it mandate were toward inflation than full employment. By acknowledging the risks have moved more into balance, Fed officials have grown more confident that inflation is on a sustainable path back toward the 2% target, while the extent of the restrictive policy is no longer necessary. Simply put, the economy is no longer overheating. One of the implications is that barring a significant surprise, the PCE deflator has lost some of its market impact, and in any event, after the CPI and PPI reports, tends not to be volatile relative to expectations. For the record, the headline and core PCE deflators are projected to rise by 0.2%. This will translate into a small rise to 2.6% (from 2.5%) in the headline and 2.7% (from 2.6%) for the core rate. Looking further ahead, the early forecasts for August jobs growth is about 155k (114k in July). The unemployment rate rose for four consecutive months through July, but may have slipped in August (to 4.2% from 4.3%).
The Dollar Index fell to a new low for the year at the end of last week, near 100.60. Since early July, the Dollar Index has fallen from 106.00. The last leg down began August 15 from above 103.00. While we suspect that large structured positions are being unwound, a corrective/consolidative phase seems increasingly likely and anticipate the momentum indicators to turn higher for oversold levels in the coming day. Initial resistance is seen in the 101.60-102.00 area.
Eurozone
The highlight is the preliminary August CPI. A small decline in the year-over-year rate is likely. It stood at 2.6% in July. The August 2023 0.5% increase will drop out of the 12-month comparison and be replaced with a 0.2%-0.3% increase. EMU’s CPI has bounced between 2.4% and 2.6% for the past six months. It looks poised to stay in that range a bit longer. Nevertheless, the market is convinced that the ECB will cut rates again at its September 12 meeting and again before the end of the year. In fact, the swaps market has 70 bp of cuts discounted by the end of the year. The US two-year premium over Germany is below 155 bp. It has not been below 150 bp since May 2023.
The euro set a new high for the year ahead of the weekend at $1.12. Even though the momentum indicators have not turned, we think the risk-reward cautions against chasing it higher before a corrective phase unfolds, which could materialize in the run-up to the US employment data on September 6. During this period, the euro can fall into the $1.1000-$1.1050 area, to give some sense of the magnitude that seems initially reasonable.
Japan
It seems clear that the Bank of Japan wants to continue normalizing monetary policy, but the largest stock market crash since 1987 gave them fright. Japanese investors have taken advantage of the yen’s strength to buy foreign assets, especially bonds. The domestic equity market has stabilized. The Nikkei has rallied nearly 24% off the August 5 panic lows. The Topix has retraced almost 2/3 of its losses from the multi-year-high set on July 11. The swaps market is pricing slightly more than 11 basis points of tightening before the end of the year, a new high. The upcoming data includes unemployment, retail sales, industrial production, and Tokyo’s CPI. Japan’s unemployment rate was steady at 2.6% from February through May before slipping to 2.5% in June. It has not been below 2.5% since the pandemic. Arguably boosted by rising wages, retail sales on a year-over-year basis rose every month in Q2, and at 3.7% in June was the best since February. That said, household spending, reported in real terms, has been contracting since November 2022, with two exceptions (April 2024 and February 2023). In GDP calculations, consumption fell for four consecutive quarters before rising in Q2 24. Japan reported a 7.9% drop in June’s industrial output from a year ago. It was the largest fall since September 2021. On a monthly basis, it fell by 4.2%, offsetting in full May’s 3.6% increase. Perhaps the most market-sensitive data point is Tokyo’s August CPI. It is released a few weeks ahead of the national reading and does a good job anticipating it–like the preliminary eurozone estimate for CPI. Tokyo’s headline and core (excludes fresh food) were at 2.2% in July, and likely remained near there in August. The headline rate peaked at 3.9% at the end of 2022 and was at 2.4% at the end of last year. The core rate peaked at 4.3% at the start of last year and stood at 2.1% at the end of 2023. It reached 1.6% in April before firming in May through July. There is nothing here to suggest that the BOJ should not continue to normalize monetary policy.
The key to the near-term movement of the yen is not to be found in Tokyo or the BOJ, but the direction of US interest rates. The dollar finished last week near JPY144, dragged lower by the drop in US yields, and the 10-year Treasury yield settled near 3.80%. A break of JPY144 could see a return to the turmoil-low from August 5 around JPY141.70. Initial resistance may be JPY145.00-JPY145.50.
Australia
Reserve Bank Governor Bullock had a reputation of being a bit soft on inflation before taking her post almost a year ago. She is now seen as among the most hawkish, and told parliament earlier this month that it was premature to think about cutting rates. The RBA does not anticipate inflation falling back into the 2-3% target range until late 2025. Early on August 28, the July month CPI print is due. It peaked in December 2022 at 8.4% and was at 3.4% at the end of last year. It reached 4% in May before slipping to 2.8% in June. The trimmed mean measure has been above 4.0% where it finished last year, every month in Q2. Bullock is also concerned that demand is outstripping capacity. July retail sales will be reported on August 30. They rose by an average of 0.4% a month in H1 24 after an average of 0.1% in H1 23. The market has not been fully persuaded by Bullock and the RBA. The futures market continues to discount a nearly 90% chance of a rate cut by the end of the year and at least three cuts in 2025.
The Australian dollar was near $0.6800 before the market turmoil struck in the second half of July. The Aussie tumble to the year’s low (~$0.6350) on August 5. It recovered, and at the end of last week, approached $0.6800. The momentum indicators are stretched, but do not necessarily rule out a new high. The high for the year was set on January 2 near $0.6840. A break of $0.6700 area is needed to confirm a near-term top.
UK
Outside of the Bank of Japan, the Bank of England may be the only G7 central bank that most likely will not cut rates next month. Still, before the end of the year, the swaps market is discounting the second cut in the cycle and around an 80% chance of a third cut. The economic calendar is light in terms of market-moving data points (consumer credit, mortgage lending and approvals). Sterling is easily the best performing G10 currency this year, gaining 3.7% on the dollar and 2.4% against the euro. And leaving aside the Danish krone that is allowed to only trade in a tight range against the euro, the other G10 currencies have fallen between about 0.5% (Australian dollar) to 3.3% (Norwegian krone).
Sterling had its best week of the year, rising by about 2.0%, and reaching levels not seen since Q1 22 (~$1.3230). It has appreciated by a little more than 5.5-cents since the August 8 low. It has fallen in one session in the last 13 sessions. The momentum indicators are stretched, but the close was strong, maybe too strong. It settled well above the upper Bollinger Band (~$1.3150), as it did every session last week. The next important chart area may be the $1.3300-$1.3330 area. Initial support may be in the $1.3130 area.
Canada
Canada reports June and Q2 GDP. Growth looks on par with Q1 (1.7% annualized), maybe a touch slower. Barring a significant surprise, the market impact will likely be minor at best. Last week’s subdued CPI seemed to validate the market’s confidence of a rate cut at the September 4 central bank meeting. It will be the third cut in the cycle, and the market is pricing at least two more after that this year. The fact that the Canadian dollar has fallen below its 200-day moving average means the front-loading of rate cuts has not taken an undue toll on the exchange rate. This may give the Bank of Canada more comfort in cutting rates, among the most aggressive within the G10.
The 0.75% gain ahead of the weekend was the Canadian dollar’s best day of the year. It lifted the weekly gain to about 1.25%, which was also the best this year. The greenback set the high for the year on August 5 (~CAD1.3945) and, before the weekend, tested CAD1.35. April 4 was the last time the US dollar traded below CAD1.35. A break could spur a quick move toward CAD1.3450. Still, momentum indicators are stretched, and the greenback settled below its lower Bollinger Band (~CAD1.3535). The CAD1.36 area, which was support, may become resistance.
Mexico
President-elect Sheinbaum is expected to name the new CEO of the Pemex on Monday. The most important economic data point is the Tuesday trade report. There is a strong seasonal tendency for Mexico’s trade balance to deteriorate sequentially in July from June. In the past 20 years, it has only improved twice. Mexico recorded a $1.04 bln in June. Mexico’s monthly trade deficit has averaged $916 mln in H1 24 (-1.09 bln in H1 23). Exports were about 2.5% higher in H1 24 from H1 23, while imports were 2.2% higher. The central bank’s inflation report will be released Wednesday. The swaps market has another rate cut discounted in the next three months. The central bank has already delivered two. Last week, the inflation report covering the first half of August showed a new decline in the headline rate, and more impressively, the core rate slipped below 4.0% for the first time in three-and-a-half years.
The peso’s four-day slide ended with aplomb ahead of the weekend with a 2.3% surge. It led the emerging market currency rally as the dollar suffered broad and deep losses. Six emerging market currencies, three of which were from Latam, rose by 1% or more before the weekend. The dollar pulled back from above MXN19.50 to settle below MXN19.10. It tested MXN19.00 and the 20-day moving average and the (61.8%) retracement of the last week’s gains converge in the MXN18.95-MXN18.96 area. We had identified resistance near MXN19.60 and saw support around MXN18.60.
China
The PBOC appears to be in the process of downgrading the significance of the one-year Medium-Term Lending Facility rate in favor of a shorter-term rate (seven-day repo). It has also pushed the setting of it to after the prime loan rates are set. Previously, a cut in the MLF rate spurred expectations of a cut in the prime rates. This serves to decouple the two. That said, the PBOC will likely boost the loans through the facility. Next Saturday, China reports its August PMI. The composite has fallen for four consecutive months through July and at 50.2, it is the lowest since the end of 2022. China’s macroeconomic data lack internal and external consistency. Yet, the performance of the offshore yuan seems more sensitive to the general direction of the yen and carry-trade strategies than the macroeconomic data per se. The offshore yuan has risen by about 2.5% against the dollar since July 1 and the rally seems to have little to do with what is happening in China. The dollar settled near its low for the week against the yen and against the yuan. In the middle of last week, the dollar approached CNH7.1125. The greenback encountered selling pressure in the second half of last week near CNH7.15. The onshore yuan has appreciated for five consecutive weeks, its longest advance in nearly 3.5 years.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
