Dollar Firm Ahead of Jobs Report

• Fed officials continued their communication push; Fed tightening expectations should move higher; the July jobs report is the main event; Canada also reports July jobs data
  
• Several eurozone countries reported June IP; ECB tightening expectations remain depressed; BOE hiked rates 50 bp to 1.75%, as expected; updated forecasts were grim; Czech Republic delivered a dovish surprise and kept rates steady at 7.0%
  
• Japan reported firm June labor cash earnings and household spending; RBA released its Statement on Monetary Policy; India hiked rates 50 bp to 5.40% vs. 35 bp expected
  

The dollar is firm ahead of the jobs data. DXY has risen 3 of the past 4 days and is trading near 106 currently. The euro remains heavy above $1.02 and we believe it remains on track to test the July 27 low near $1.0095, weighed down by the weak eurozone outlook and lower ECB tightening expectations. Sterling has recovered from its post-BOE sell-off but remains heavy above $1.21 as the U.K. fundamental outlook remains poor (see below). We believe it is still on track to break below the July 29 low near $1.2065. If weakness continues as we expect, the July 21 low near $1.1890 comes into focus. USD/JPY remains stuck near 133 after the recent rally ran out of steam near 134.50. We maintain our strong dollar call as Fed officials are making it clear that markets misread the Fed's commitment to lowering inflation. The greenback is also getting more traction as data came in stronger than expected. Today's jobs data will likely be key for the medium-term dollar outlook.

AMERICAS

Fed officials continued their communication push. Mester spoke again yesterday and remained hawkish. She said that the rate path outlined in the June Dot Plots is "about right." Mester added that "We raise interest rates, and then when we get up to a sufficiently high level where we've seen that compelling evidence, then we hold them there for a while, and then we can bring them back down, right as we get inflation closer to goal." Mester said another 75 bp hike in September is "not unreasonable" but noted 50 bp is also an option. She said she may support front-loading more of her projected rate increases but added that it will depend on the incoming data. Only Barkin speaks today.

Fed tightening expectations should move higher. WIRP suggests a 50 bp hike September 21 is fully priced in, with around 40% odds of a larger 75 bp move. The swaps market is pricing in 100 bp of tightening over the next 6 months that sees the policy rate peak near 3.5%, followed by the start o an easing cycle over the subsequent 6 months. The Fed has made it clear that this is not its expected rate path and so we look for a hawkish shift in market pricing in the coming days and weeks if the U.S. data cooperate.

The July jobs report is the main event. Consensus sees 250k jobs added vs. 372k in June, while the unemployment rate is expected to remain steady at 3.6% and average hourly earnings are seen falling two ticks to 4.9% y/y. Fed Chair Powell stressed labor market strength many times in his post-decision press conference, which supports our view that the Fed is not about to pivot while the economy remains at full employment. June consumer credit will be also reported and is expected at $27.0 bln vs. $22.347 bln in May.

Canada also reports July jobs data. Consensus sees 15.0k jobs added vs. -43.2k in June, while the unemployment rate is expected to rise a tick to 5.0%. July Ivey PMI will be reported. Bank of Canada meets September 7 and a 50 bp hike is fully priced in, with nearly 55% odds of a 75 bp move. The swaps market is pricing in only 100 bp of tightening over the next 6 months that would see the policy rate peak near 3.5%, followed by the start of an easing cycle the subsequent 6 months. We disagree with this expected pivot by the BOC.

EUROPE/MIDDLE EAST/AFRICA

Several eurozone countries reported June IP. Germany came in at 0.4% m/m vs. -0.3% expected, France came in at 1.4% m/m vs. -0.3% expected, Italy came in at -2.1% m/m vs. -0.1% expected, and Spain came in at 1.1% m/m vs. -0.1% expected, The eurozone reading will be reported next Friday and is expected at 0.1% m/m.

ECB tightening expectations remain depressed. WIRP suggests 50 bp hikes are no longer priced in for the next meetings September 8 and October 27. Looking ahead, the swaps market is now pricing in 125 bp of tightening over the next 12 months that would see the deposit rate rise to 1.25%.

Bank of England hiked rates 50 bp to 1.75%, as expected. The vote was 8-1, with Tenreyro voting for a smaller 25 bp move. The bank said that future policy is not on a pre-set path, which markets took as a dovish pivot. In his Press conference, Governor Bailey also emphasized that all options are on the table for future meetings and policy is not on a pre-set path, adding that a 50 bp hike lowers the risk of a more extended tightening cycle. The BOE also laid out its plans for Quantitative Tightening, which has active sales of its holdings starting after a vote in September. The bank estimated that sales will be around GBP10 bln per quarter. Including redemptions, the estimates that its gilt holding will decline around GBP80 bln in the first year of QT. Sales of its much smaller corporate bond holding will begin the week of September 19. Bank officials said there would be a "high bar" to altering the plan.

Updated forecasts were grim. The bank sees the economy entering recession in Q4 and the downturn is forecast to last five quarters. It sees 13% inflation this year vs. 10.25% previously, falling to 5.5% next year vs. 3.5% previously. Worse yet, -1.5% GDP is forecast next year vs. -0.25% previously and -0.25% for 2024 vs. +0.25% previously. Unemployment forecasts were also higher, with 2023 at 4.75% vs. 4.25% previously and 2024 at 5.75% vs. 5.0% previously. Obviously, the risks are that these forecasts are too optimistic.

BOE tightening expectations are still adjusting. WIRP suggests a 50 bp hike September 15 is about 80% priced in, while odds of a 50 bp hike November 3 are even lower. Looking ahead, the swaps market is pricing in 125 bp of tightening over the next 6 months that would see the policy rate peak near 3.0%. Chief Economy Pill speaks today. Given the grim BOE outlook, we think sterling should be much lower. Cable tested the July 29 low near $1.2065 during Bailey's presser but it held for now. If losses continue as we expect, a break below $1.2045 would set up a test of the July 21 low near $1.1890.

Czech National Bank delivered a dovish surprise and kept rates steady at 7.0% vs. an expected 25 bp hike. The vote was 5-2, with the two dissents in favor of a 100 bp hike. This was the first meeting led by new Governor Michl, who voted against every hike in this cycle. Making things worse, the makeup of the board shifted drastically as three hawks were replaced by doves and so the dovish outcome shouldn't be too shocking. Michl said that curbing inflation is the bank's top priority, but shifted its policy framework to get inflation back to target within 18-24 months vs. 12-18 months previously. The bank raised its average 2022 forecast to 16.5% and its average 2023 forecast to 9.5%, and warned that inflation could reach 20% by year-end. We know the bank was nearing the end of the tightening cycle but we didn't think it was quite there yet. Next policy meeting is September 29 and the bank said it will decide then whether to keep rates steady or hike. The swaps market sees steady rates over the next 12 months, followed by the start of an easing cycle over the subsequent 12 months. Maybe it's just us but a 7% nominal policy when inflation is 17.2% and rising doesn't seem to be restrictive enough. We'd be a buyer of EUR/CZK on this dip, as this pair should be higher after this dovish surprise, not lower.

ASIA

Japan reported firm June labor cash earnings and household spending. Nominal earnings rose 2.2% y/y vs. 1.9% expected and 1.0% in May, while real earnings came in at -0.4% y/y vs. -1.3% expected and -1.8% in May. Spending jumped 3.5% y/y vs. 1.5% expected and -0.5% in May. The issue of wages has moved to the forefront after Deputy Governor Amamiya said recently that he expects wage pressures to pick up next year. While he downplayed the need to tighten, we do know that others at the BOJ believe wage growth must pick up along with inflation in order to get a policy shift. The gain in spending is welcome, though we suspect it will weaken a bit in July as the virus numbers picked up sharply last month.

Reserve Bank of Australia released its Statement on Monetary Policy. Macro forecasts were updated and December 2024 was added to the forecast horizon. Of note, inflation is seen staying above the 2-3% target range and unemployment is seen remaining below 4% through end-2024. The RBA said that this central scenario assumes the cash rate will rise to 3% by this December from 1.85% currently and then "decline a little" by end-2024. The exchange rate is assumed to be stable. WIRP suggests a 25 bp hike September 6 is fully priced in, with around 45% odds of a larger 50 bp move. The swaps market sees 150 bp of tightening over the next 12 months that would see the cash rate peak near 3.35%.

Reserve Bank of India hiked rates 50 bp to 5.40% vs. 35 bp expected. However, markets were split as nearly half the analysts polled by Bloomberg saw a 50 bp hike. Governor Das said "Inflationary pressures are broad based and core inflation remains elevated," noting that inflation will remain above the 2-6% target band for the current FY ending in March. He stressed that "It's now basically a whatever-it-takes approach going into third year in succession." CPI rose 7.01% y/y in June, down for the second straight month from the 7.79% peak in April but still above the 3-6% target range. Next policy meeting is September 30 and another 50 bp hike then seems likely, with risks of a smaller move if inflation continues to fall. The swaps market is pricing in 90 bp of tightening over the next 12 months that would see the policy rate peak near 6.3%.

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