Brown Brothers Harriman & Co.

09/15/2021 | News release | Distributed by Public on 09/15/2021 06:17

Dollar Remains Soft After CPI Data

  • August CPI is worth discussing; elevated PPI inflation suggests price pressures remain in play; regional Fed manufacturing surveys for September will start rolling out; Canada data highlight will be August CPI; Brazil rates were sharply lower after BCB President Campos Neto signaled he won't overreact to the latest inflation print
  • ECB asset purchases for the week ending September 10 were reported; eurozone reported firm July IP; U.K. reported higher than expected August CPI; short sterling strip is now fully pricing lift-off in Q1 2022 and two hikes in 2022; Turkish Central Bank (CBRT) raised its FX deposit reserve requirement by 200 bp
  • Japan Chief Cabinet Secretary Kato said reopening the economy will start in low-risk areas and proceed cautiously; China reported weak data; Indonesia reported a much-higher-than-expected trade surplus at $4.7 bln in August

The dollar is softer in the wake of the CPI data (see below). DXY is down for the second straight day after two straight up days and is trading just below 92.50. A break above 93.048 is needed to set up a test of the August 20 high near 93.729. The euro found support near $1.18 but feels heavy, and a break below $1.1760 is needed set up a test of the August 20 low near $1.1665. Sterling found support near $1.38 on firm CPI readings (see below), while USD/JPY is trading at the lowest level since August 17 near 109.30 and the break below 109.50 today sets up a test of the August 4 low near 108.70. We remain positive on the dollar but acknowledge that a sustained rally will depend largely on the economic data in the coming days and weeks.

AMERICAS

August CPI is worth discussing. While many are already crowing that the readings validate the Fed's transitory narrative, we are not yet convinced. Headline did ease a tick as expected to 5.3% y/y, while core eased to 4.0% y/y vs. 4.2% expected and 4.3% in July. The m/m gains did slow for the second straight month, with headline up 0.3% and core up 0.1%. This slowdown was driven largely by declines in used cars (-1.5% m/m), hotels/motels (-3.3%), and airfare (-9.1%) as the delta variant spread and so these can easily reverse higher.
Looking ahead, elevated PPI inflation suggests price pressures remain in play. Headline PPI rose 8.3% y/y vs. 7.8% in July and core rose 6.7% y/y vs. 6.2% in July and so there are still risks that CPI moves higher again in the coming months. Recall that the latest Fed Beige Book noted that more businesses across the nation were finding it easier to pass through higher costs to their customers. Studies also suggest a high degree of correlation between China PPI and U.S. core CPI. The former rose 9.5% y/y in August, the highest since August 2008.

Regional Fed manufacturing surveys for September will start rolling out. Empire survey kicks things off today and is expected at 17.9 vs. 18.3 in August. Philly Fed will follow tomorrow and is expected at 19.0 vs. 19.4 in August. August IP will also be reported today and is expected to rise 0.5% m/m vs. 0.9% in July. The August Fed surveys were mostly softer but were down from historically high levels. Some further moderation is to be expected in the coming months but we see underlying strength continuing in the U.S. manufacturing sector.

Canada data highlight will be August CPI. Headline is expected at 3.9% y/y vs. 3.7% in July, while common core is expected to pick up a tick to 1.8% y/y. Canada also reports August existing home sales. Last week, the Bank of Canada delivered a dovish hold and still views the current spike in inflation as transitory. On the other hand, the bank seemed unfazed by the shock Q2 GDP contraction and sees a rebound in H2. Current forward guidance points to likely lift-off in H2 2022. If the data hold up, the BOC is likely to taper again in late 2021 or early 2022. Next policy meeting is October 27.

Brazil rates were sharply lower after BCB President Campos Neto signaled he won't overreact to the latest inflation print. He said, 'the central bank will [not] react to every high-frequency data point.' The comments dampen growing bets for a 125 bp hike at the next meeting September 22, most likely sticking to the 100 bp pace from the last meeting. Swaps futures are down as much as 26 bp across the curve, especially around the early 2022 sector. BRL underperformed yesterday on weakening carry prospects, down 0.5% against the dollar.

EUROPE/MIDDLE EAST/AFRICA

ECB asset purchases for the week ending September 10 were reported. This weekly number has taken on more importance after the ECB last week announced that it would aim for a more 'moderate' pace going forward. Net purchases were EUR14.7 bln vs. EUR16.7 bln for the week ending September 3 and EUR11.5 bln for the week ending August 27. The ECB had been aiming for net weekly purchases of around EUR20 bln since the accelerated pace began in March but they have fallen a bit short in recent weeks due to thin market conditions over the summer. Now, it will likely take a few more weeks to figure out what the new pace will be. Redemptions last week were quite high at EUR6.1 bln, which put gross purchases at a sizable EUR20.8 bln, the highest since late July.

Eurozone reported firm July IP. It was expected to rise 0.6% m/m but instead rose 1.5%, while June was revised up to -0.1% m/m from -0.3% previously. With the economy firm and inflation high, the ECB hawks won the battle by engineering a modest slowdown in asset purchases. However, many more battles lie ahead. Lagarde said that the decision about the future of PEPP would be made at the December 16 meeting. This basically renders the October 28 meeting a non-event. However, we expect the hawks and the doves to stake out their positions ahead of December. As always, much will come down to how the data come in between now and then.

U.K. reported higher than expected August CPI. Headline rose 3.2% y/y vs. 2.9% expected and 2.0% in July, while CPIH rose 3.0% y/y vs. 2.7% expected and 2.1% in July. Of note, the biggest price increases came from hotels and restaurants as the economy fully reopened but the ONS said that much of these gains in August will likely be temporary.

The short sterling strip is now fully pricing lift-off in Q1 2022 and two hikes in 2022, but we are not convinced. For one thing, the BOE forecasts a spike in inflation this year but views it as temporary. The inflation forecasts from the August 5 decision were 4.0% (vs. 2.5% in May) in 2021, 2.5% (2.0%) in 2022, and 2.0% (2.0%) in 2023. To us, these forecasts suggest no hurry to hike and no need to hike aggressively. Indeed, MPC member Saunders recently pushed back against aggressive market tightening expectations. Next Bank of England decision is due September 23. While we expect another dovish hold due to soft real sector data, there is a slight risk of a more hawkish tilt.

The Turkish Central Bank (CBRT) raised its FX deposit reserve requirement by 200 bp. The new rate for deposits up to one year will be 23% and for longer will be 17%, starting September 17. The goal here is to disincentivize dollar deposits in favor of lira deposits, with the aim of supporting the currency. We remain unconvinced and hope this move doesn't give CBRT officials a false sense of comfort to pull the trigger in easing rates. The lira is little changed on the news and once again our suspicion is lack of investor participation altogether.

ASIA

Japan Chief Cabinet Secretary Kato said reopening the economy will start in low-risk areas and proceed cautiously. He stressed that the gradual approach will require the cooperation of businesses and the understanding of the public, noting 'We're not going to suddenly say there's no need to hold back at all. Infections can happen even if you're vaccinated. So we will be asking people to take precautions as we move to show a roadmap toward loosening restrictions.' The state of emergency was just extended through month-end but with virus numbers fallings, officials are clearly looking ahead to reopening the economy in Q4. Elsewhere, Japan reported July core machine orders. They were expected to rise 2.5% m/m but came in at 0.9% vs. -1.5% in June. The economy is holding up better than expected in Q3 so far and if the lockdowns ease in October, the outlook for Q4 will greatly improve.

China reported weak data. The lower-than-expected retail sales out of China is consistent with the recent delta variant downdraft in the consumer-side data and boosts the odds of policy action. August retail sales decelerated to just 2.5% y/y, well below the 7.0% expected and the 8.5% the previous month. Industrial production came in slightly below expectations at 5.3% y/y. The usual pandemic gap between the consumer and industrial sectors is returning to China, and we expect policy makers to react accordingly. We don't expect any heavy-handed moves, but another RRR cut is likely in the making, along with targeted measures to support the weaker spots in the economy.

Indonesia reported a much-higher-than-expected trade surplus at $4.7 bln in August, twice the expected figure. Exports rose a whopping 64.1% y/y while imports jumped 55.3% y/y. The commodity sector dominated, with oil and gas exports up 78.2% and mining also rising dramatically. We are not seeing much reaction in markets with IDR flat on the day, but believe the better outlook for the country's current account will provide a meaningful tailwind for the currency going forward.