Drivers for the Week Ahead

  • The dollar has strengthened as we enter what is perhaps the most eventful week of the year
  • The FOMC meets Wednesday and is widely expected to cut rates 25 bp
  • White House advisor Kudlow ruled out any sort of currency intervention by the US
  • The US July jobs report Friday will be the key data release this week
  • US-China trade talks resume Monday in Shanghai; China reports official July PMI readings Tuesday
  • Bank of Japan meets Tuesday; Bank of England meets Thursday
  • In EM, the central banks of Brazil and Czech Republic meet

The dollar has strengthened as we enter what is perhaps the most eventful week of the year.  Besides three major central bank meetings, we will also get important July PMI and jobs data for the US.  Fundamental drivers still favor the dollar and we remain bullish on the greenback.  Last week’s dovish tilt by the ECB should have been EM-supportive.  However, global trade tensions remain high despite the rebooted US-China talks in Shanghai this week and so we remain bearish on EM FX.

The FOMC meets Wednesday and is widely expected to cut rates 25 bp.  There will no updated staff forecasts nor Dot Plots, both of which will come at the September 18 meeting.  If the Fed does move, it will be the first time it has changed policy at a meeting without fresh forecasts.  Chair Powell will give his usual press conference after the decision.  With the media embargo ending, Fed officials will hit the trail starting in August to help manage market expectations.

WIRP suggests 16% odds of a 50 bp cut, down sharply from nearly 50% right after the Williams comments.  The implied yield on the January 2020 Fed Funds futures contract is currently around 1.74%.  While this is the highest since July 11, it still prices in nearly three cuts in total this year.  After the likely 25 bp cut this week, we just can’t see the Fed pre-committing to any more cuts.  As such, we expect a wait-and-see period that will make three cuts this year nearly impossible.

White House advisor Kudlow ruled out any sort of currency intervention by the US.  There is more to this story than meets the eye.  While Kudlow made the statement during a live interview Friday, it appears that a serious debate took place between senior US officials about whether they should try to weaken the dollar and if so, the best method to do so.  Direct FX intervention and jawboning were discussed and rejected.  Kudlow apparently thought the matter was closed.

Apparently not, as President Trump further muddied the waters.  He said late Friday afternoon that “I didn’t say I’m not going to do something” about the strong dollar, thereby contradicting Kudlow’s earlier statement.  We’ve seen this sort of capricious policymaking before from this administration.  While it’s clear that we cannot rule out FX intervention to weaken the dollar, we believe cooler heads will prevail and the US will limit its efforts to jawboning, which has limited impact.

Furthermore, it’s unlikely that unilateral FX intervention would have much lasting impact when interest rate differentials continue to favor the dollar.  To repeat, we remain dollar bulls and continue to believe that markets are overestimating the Fed’s capacity to ease after this week’s likely 25 bp cut.  We will discuss the prospects for unilateral FX intervention by the US in a MarketView piece later this week.

That the dollar is rallying without much support from the US rates markets is remarkable.  While we think much of the dollar’s recent gains reflect the worsening outlook in the rest of the world, the improved US economic outlook is undeniable.

Last Friday’s Q2 GDP report was stronger than expected.  While the 2.1% SAAR reading is unlikely to have any impact on Fed policy this week, it nevertheless underscores the fact that the US economy is in better shape than many expect.  Indeed, the NY Fed’s Nowcast model estimated Q3 GDP growth at 2.2% SAAR, up from 1.9% the previous week.  Trend growth for the US is widely accepted to be around 2%.

The US July jobs report Friday will be the key data release this week.  Consensus sees 169k jobs added vs. 224k in June.  Average hourly earnings are seen steady at 3.1% y/y, as is the unemployment rate at 3.7%.  Ahead of that, ADP jobs data will be reported Wednesday.  Consensus there stands at 150k.

The Dallas Fed reports its July manufacturing index Monday (-5 expected).  This will be the last of the regional Fed manufacturing surveys for July, with two coming in stronger than expected and two weaker than expected.  It will be followed by Chicago PMI Wednesday (51.5 expected) and ISM manufacturing Thursday (52.0 expected).

There is a lot more US data out this week.  US June personal income and spending, core PCE (1.7% y/y expected), pending home sales, and July Conference Board consumer confidence will be reported Tuesday.  June construction spending, July Challenger job cuts, and auto sales (16.9 mln expected) will be reported Thursday.  June trade (-$54.6 bln expected) factory orders (0.8% m/m expected), and July Michigan consumer sentiment will be reported Friday.

US-China trade talks resume Monday in Shanghai.  These are the first face-to-face talks since negotiations broke down in May.  While both sides are putting on a brave face, reports suggest the two sides remain far apart in key areas such as structural reforms in China.  Trump speculated that China may want to delay a trade deal until after the 2020 US elections.  We do not believe this to be the case, as neither country can afford to wait that long to resolve the current dispute.

China reports official July PMI readings Tuesday.  Manufacturing is expected at 49.6 and non-manufacturing at 54.0.  Caixin reports its July manufacturing PMI Thursday, which is expected at 49.6 vs. 49.4 in June.  These will be first glimpses of July activity and are likely to show little improvement as long as the US-China trade war drags on.

Bank of Japan meets Tuesday and is widely expected to keep policy on hold.  WIRP suggests a 13% change of a cut then.  However, the odds of a cut rise as we move through Q4 to 70% for the December 19 meeting.  This reflects the widely held belief that the BOJ will wait until after the October consumption tax hike before adding any more stimulus.  Ahead of that meeting, Japan reports June retail sales Monday (-0.3% m/m expected), followed by unemployment and IP Tuesday (-1.8% m/m expected).

Bank of England meets Thursday and is widely expected to keep policy on hold.  WIRP suggests a mere 2% chance of a cut then.  However, the odds of a cut rise sharply as we move through Q4 and into 2020 to 66% for the March 26 meeting.  That same day, the UK reports July manufacturing PMI and it is expected at 47.7 vs. 48.0 in June.  Construction PMI will be reported Friday, which is expected at 46.0 vs. 43.1 in June.  Data are expected to remain soft ahead of the October 31 Brexit deadline.

Canada reports May GDP Wednesday, which is expected to grow 1.3% y/y vs. 1.5% in April.  It then reports June trade Thursday.  Next BOC meeting is September 4 and no change is expected.  WIRP suggests 9% odds of a cut then but rise as we move into Q4 to 45% for the December 4 meeting.

Australia reports Q2 CPI Wednesday.  Headline inflation is expected at 1.5% y/y vs. 1.3% in Q1, while the trimmed mean is expected at 1.5% y/y vs. 1.6% in Q1.  June retail sales will be reported Friday and are expected to rise 0.3% m/m vs. 0.1% in May.  Next RBA meeting is August 6 and no change is expected.  WIRP suggests 21% odds of a cut then but rise as we move into Q4 to 80% for the November 5 meeting.

In EM, the central banks of Brazil and Czech Republic meet.  Of the two, Brazil is the only one expected to move and it is likely to start the easing cycle with a 25 bp cut to 6.25%.  However, the market is somewhat split and some look for a 50 bp cut and some for no cut.  If it cuts, Brazil would follow Turkey and Russia in cutting rates just last week and many others in recent months.