Drivers for the Week Ahead

  • We remain dollar bulls
  • The US has a heavy schedule of data releases this week, mostly minor
  • Even though the FOMC media embargo has ended, Fed speaking engagements this week are light
  • UK and Japan have a fairly heavy data week
  • RBA is expected to keep rates steady; RBNZ is expected to cut rates 25 bp
  • EM remains under severe pressure

We remain dollar bulls.  But just like the Fed, we are struggling with how to compensate for a trade war.  That the dollar continues to rally suggests the safe haven bid is overwhelming the slide in US interest rates.  Or perhaps the greenback’s gains still reflect the fact that the US economy is likely to be the most resilient within this deteriorating backdrop.

US rates markets have reacted to the renewed tariff threats.  The implied yield on the January 2020 Fed Funds futures contract has fallen to 1.56% from 1.80% last week.  Two more cuts are now back to being fully priced in, with a third now on deck.  WIRP suggests 100% odds of a cut at the next meeting September 18.  Powell himself admitted that the Fed is still trying to figure out how to react to global trade tensions.  Markets clearly believe the Fed will bail Trump out again.  We are not so sure, as we believe that the Fed simply cannot reward bad trade and fiscal policies with rate cuts.

The US has heavy schedule of data releases this week, mostly minor.  ISM July non-manufacturing PMI will be reported Monday and is expected at 55.5 vs. 55.1 in June.  Final Markit services and composite PMIs will also be reported Monday.  June JOLTS job openings will be reported Tuesday, followed by June consumer credit Wednesday.  Weekly jobless claims and June wholesale trade sales and inventories will be reported Thursday.

The most important US reading will be July PPI Friday.  Headline is expected to remain steady at 1.7% y/y while core is expected to rise a tick to 2.4% y/y.  This will set the table for July CPI, to be reported next Tuesday.  Powell said that this most recent rate cut was meant to help push inflation higher.

We think Powell was right to refrain from pre-committing to more cuts.  The US economy remains in solid shape, further evidenced by the 164k gain in jobs last month.  The Atlanta Fed’s GDPNow model is tracking 1.9% SAAR growth in Q3, down from 2.2% previously.  This is still close to trend (~2%) and little changed from the preliminary 2.1% SAAR in Q2.  Elsewhere, the NY Fed’s Nowcast model is tracking 1.6% SAAR growth in Q3, down from 2.2% the previous week.

Even though the FOMC media embargo has ended, Fed speaking engagements this week are light.  The only ones on the schedule are Brainard Monday, Bullard Tuesday, and Evans Wednesday.  Meanwhile, George said Friday that she dissented because the data and outlook warranted no change in rates, adding she is open to incoming data to prove her wrong.

Final July eurozone services and composite PMI readings will be reported Monday.  Headline composite is expected to remain at the 51.5 flash reading.  Looking at the country breakdown, Germany composite is expected to remain at the 51.4 flash reading and France is expected to remain steady at the 51.7 flash reading.  Italy composite is expected to remain steady at 50.1 in June, while Spain is expected to drop a tick 52.0 from 52.1 in June.   Elsewhere, Germany reports June factory orders Tuesday, IP Wednesday, and trade and current account Friday.

That the entire German curve out to 30 years is under water says something is very, very wrong in the eurozone.  Italy can borrow for 10 years at rates lower than the US, while Greece must pay a mere 15 bp more than us.  The eurozone economy is clearly slowing and WIRP suggests 100% chance of a cut September 12.  But what will a 10 bp rate cut by the ECB really do?

UK has a very heavy data week.  July PMI readings will wrap up Monday with services and composite PMI to be reported.  They are expected at 50.3 and 49.8, respectively, and follows manufacturing (48.0) and construction (45.3) reported last week.  Friday sees Q2 GDP, June IP, construction output, and trade.  The BOE delivered what we consider to be a dovish hold last week, but WIRP suggests odds of a cut at the September 19 meeting are only 5%.

Japan has a fairly heavy data week.  June household spending and labor cash earnings will be reported Tuesday.  June current account data will be reported Thursday.  Q2 GDP will be reported Friday, with annualized growth expected to slow to 0.6% from 2.2% in Q1.  BOJ next meets September 19 and WIRP suggests 25% odds of a cut then.

Reserve Bank of Australia meets Tuesday and is expected to keep rates steady at 1.0%.  It will release its Statement on Monetary Policy Friday.  Ahead of the decision, Australia reports June trade that same day.  The RBA has signaled that it wants to gauge the impact of its back-to-back cuts before moving again.  However, WIRP shows rising odds of a cut as we move into Q4, with 61% chance of a cut October 1 and 80% November 5.

Reserve Bank of New Zealand meets Wednesday and is expected to cut rates 25 bp to 1.25%.  Ahead of the decision, New Zealand reports Q2 employment data Tuesday.  Data have remained soft and so markets are looking for another cut after this week.

EM remains under severe pressure.  The less dovish than expected Fed, renewed trade tensions, and a broad-based dollar rally have conspired to absolutely crush EM FX and equities.  These drivers are likely to carry over into this week and so we remain bearish on EM.

In EM, the central banks of India, Thailand (both Wednesday), the Philippines (Thursday), and Peru (Friday) meet.   India and the Philippines are both expected to cut rates 25 bp.  Thailand and Peru on hold for now, but there will likely be increasing pressure for both to ease as their economics soften.  Minutes from Chile’s central bank out Friday signaled another rate cut at its next meeting September 3.

At some point, the lower carry for most of EM will end up discouraging foreign investment in EM local currency bonds.  As it is, the current bout of FX weakness will wipe out any annual fixed income returns in a matter of days.  EM equities continue to underperform DM, with MSCI EM on track to test the May low near 982.  It just broke below a key retracement objective for this year’s rally near 1004, which sets up a test of the January low near 945.50.