dollar weakness

FX Daily: Hard times to sell a hawkish narrative The Fed paused yesterday but signalled two more hikes in its dot plot. Markets, however, are not trusting the new projections, and barely price in one more 25bp increase to the peak, likely due to recent softish inflation figures. The ECB won’t have an easier task selling such hawkish rhetoric today, and EUR/USD faces some moderate downside risks.   USD: Dollar bulls can cling on to the dot plot The Federal Reserve matched market expectations for a hold yesterday, but definitely surprised on the hawkish side with its messaging. As discussed in our Fed review note, the FOMC retained maximum flexibility as it signalled openness to further rate increases: the updated dot plot rate projections were reviewed considerably higher from March, and the median projection now includes two more rate hikes in 2023, before 100bp of cuts in 2024. Remember that the March dot plot signalled we had reached the end of the tightening cycle, now only two FOMC members see rates being held at 5.25% until year-end.   The dollar had come into the FOMC announcement with a bearish tone, as PPI figures released yesterday morning showed more encouraging signs of a slowdown in inflation and prompted markets to fully price out a rate hike later in the day.   Despite the hawkish surprise contained in the Fed message – primarily in the dot plot – the dollar failed to rebound. That is because there was an evident dislocation between the Fed’s hawkish signals and the market reaction: investors are carefully weighing the evidence of slowing inflation from the CPI and PPI data, and appear – so far – reluctant to align with the Fed’s projections. The Fed funds futures curve prices in 17bp of tightening for July, and 22bp to the peak.   The post-FOMC pricing is telling us that markets accord higher credibility to data than the Fed’s communication, so more evidence of US disinflation/economic slowdown can prompt more dollar weakness moving ahead. However, with markets underpricing rate hikes compared to the dot plot, we’d be cautious before jumping on a bearish dollar trend just yet, given the high risk of market pricing converging to the Fed’s projections and pushing short-term swap rates higher again.   So, dollar bulls can probably cling on to the hawkish dot plot for now, or at least until (and if) data indicates more unequivocally that there is no longer a necessity to raise rates.   This morning, we are seeing the dollar recovering some ground, although that appears to be primarily driven by the weak activity data out of China and fresh rate cuts by the People's Bank of China.    

JPY: BoJ keeps the yen on the backfoot Last night's Bank of Japan (BoJ) meeting produced few fireworks, with the BoJ leaving all its policy levers and its statement unchanged. This has allowed the Japanese yen to remain the prime victim of higher US interest rates – with USD/JPY now pushing through 141.00. We are currently listening to Governor Kazuo Ueda's press briefing and we think there is a chance that the BoJ does tweak its policy set-up at the 28 July policy meeting, when new forecasts will be released. Until that point, however, USD/JPY may well still bid and should remain in the lead should any US data surprise on the upside. Equally, the yen will lag – and will continue to decline on the cross rates – if this current period of dollar weakness does extend after all.

It wasn't all one way though... But it would be wise not to get too carried away. Certainly, a number of outsize declines in some components drove today's big fall in inflation. But this was a messy release, with a number of interesting increases as well as decreases. Food and beverages rose 1.05% MoM, much faster than the recent trend increase. Rents, an important contributor to the housing component, continued to rise at a 0.8% MoM pace, and are showing no signs of slowing. And there was a large 1.1% MoM increase in financial prices.    In short, there was a lot of volatility in this release, and a slightly different spread of outcomes could have seen the numbers go the opposite way. So while today's numbers show a welcome moderation in inflation, especially in the core series, it is harder to pull out of this release anything that confirms that the trend in the months ahead will also remain more moderate. Retail gasoline prices in June will average higher than in May, so the transport element of today's fall will likely reverse. And in July, we will have to deal with much higher electricity tariffs (a 20% YoY increase or even more is anticipated), which will push up the utilities part of the housing component.    Base effects will continue to help the year-on-year comparisons, so we see June inflation slipping further to 5.2% YoY.  But inflation in July may go sideways, or even rise slightly, and this could be enough to persuade the RBA of the merits of a further 25bp rate hike at their September meeting, taking the cash rate to 4.35%. That decision will also likely be influenced by developments in housing and the labour market, and if these have softened substantially by then, it won't be such an obvious call.    The AUD dropped sharply on the release, which is a perfectly reasonable response, as markets pared back their expectations for RBA tightening to just over one more rate hike by the end of the year. That has a little further to be reduced in our view and could keep the AUD in this sort of range over the coming months until there is a clearer sign on the direction for US rates. The long-awaited dollar weakness is taking a while to arrive as the US economy doesn't seem to want to lie down despite the best efforts of the Federal Reserve Bank.  

EIA Crude Oil Inventory Report expected at 11am EST. **Note API reported 4.4million draw last night. Fed’s rate path remains key for gold traders Bitcoin momentum capped on rising expectations BlackRock will get a US Bitcoin ETF approved Oil  Crude prices got a boost after the API report showed stockpiles declined by 4.4 million barrels per day. Energy traders are watching a tug-of-war between bullish bets that stem from expectations that OPEC+ will keep this market tight and as global recession fears grow.  Oil will struggle here if global economies continue to drag here. It seems the news flow is steadily turning to sluggish economic growth and that is bad news for the crude demand outlook. If the next week of economic data suggests the US economy is quickly slowing down, that might trigger a weaker dollar but also calls for a much weaker consumer.   WTI crude looks like it might be stuck in a range a little longer until inventory trends become a little bit clearer.       Gold Gold prices are wavering as global central bank tightening is dragging down stocks.  Gold is starting to see some safe-haven flows despite a global bond market selloff as investors start to plan for medium term dollar weakness.  Gold looks like it might be able to stabilize above the $1900 level even if Wall Street starts to think that the September FOMC will be a live meeting.  Bearish dollar views are growing and that should become stronger once we next week’s inflation report.      Bitcoin  Bitcoin hovers around the $31,000 level as optimism grows that BlackRock will get their Bitcoin ETF done.  BlackRock CEO Larry Fink told Fox Business that “We do believe that if we can create more tokenization of assets and securities – that’s what bitcoin is – it could revolutionize finance.”  This is a major pivot from Fink and provides optimism that other crypto skeptics could change their tune in the near future.   Bitcoin appears to be facing some price barriers ahead of the $32,000 level.  Bitcoin’s performance is gaining attention given some of the weakness that is emerging with global equities.  For the Bitcoin rally to continue, we will need to get a confirmation that the SEC will grant permission for a spot-Bitcoin ETF in the US. Bitcoin remains stuck in a range again, trading between $28,000 and $31,500.       

Metals – Edging up on dollar weakness Spot gold rose to its highest level in almost four weeks, while industrial metals edged higher yesterday as easing inflation in the US pushed the dollar index to its lowest level since April 2022. Rising market speculation that the Federal Reserve's interest rate hikes may soon be nearing an end further lifted overall optimism across risk assets. China released its preliminary trade data for metals yesterday, which shows total monthly imports for unwrought copper falling 16.4% YoY to 449.6kt in June amid weak demand from the property market. Higher domestic production of the metal also impacted demand for imported copper. Cumulative unwrought copper imports fell 12% YoY to 2.6mt in the first half of the year. In contrast, imports of copper concentrate rose 3.2% YoY to 2.13mt last month, while year-to-date imports rose 7.9% YoY to 13.4mt. In ferrous metals, iron ore monthly imports rose 7.4% YoY to 95.5mt, while cumulative imports are also up 7.7% YoY to a total of 576mt in the first half of the year. On the exports side, China’s unwrought aluminium and aluminium products shipments fell 19% YoY to 492.6kt last month, while year-to-date exports declined 20% YoY to 2.81mt in the first half of 2023. Exports of steel products jumped 31% YoY to 43.6mt over the first half of the year. Recent data from China Iron and Steel Association (CISA) shows that steel inventories at major Chinese steel mills fell to 15.9mt in early July, down 7.6% compared to late June. Meanwhile, crude steel production at major mills fell marginally by 0.3% to 2.24mt/d in early July.

The US consumer price index turned out to be much weaker than forecasts, leading to a drop in yields and a sharp increase in demand for risky assets. Inflation dropped from 4% YoY to 3% (forecast at 3.1%), the core index from 5.3% to 4.8% (forecast at 5.0%). The main reason for the decrease was the group of volatile goods and services – prices for airline tickets, hotel rooms, and used cars. Fed rate futures slightly changed - the likelihood of a rate hike in July even slightly increased to 92%, while the start of the easing cycle was shifted from May to March 2024.     This is possibly due to the fact that we don't know if this pace of decline will be sustainable. Richmond Fed President Barkin spoke after the report and urged not to pay attention to the fall in inflation, as long as the labor market remains too tense, inflation could return to high levels, and then it would take much more effort.   Meester from the Cleveland Fed essentially said the same thing - as long as wage growth is 4.5-5.0%, with productivity growth of less than 1.5%, it is too early to talk about price stability. Markets quickly reacted and the dollar noticeably weakened, September Brent futures crossed the barrier of 80 dollars a barrel, while demand for commodity currencies increased. The New Zealand dollar rose sharply, despite the fact that the Reserve Bank of New Zealand kept the rate at 5.5% and hinted that it expects further inflation decline from peak levels.   USD/CAD The Bank of Canada, as expected, raised the benchmark rate by 0.25% to 5.00% at Wednesday's meeting.   The forecast for the start of the easing cycle is postponed to the indefinite future, and according to analysts at Scotiabank, another increase should be expected in September or October. The main reason for such estimates is the high likelihood that inflation in Canada is slowing down much slower than in the US, and economic growth is more stable.   The Bank of Canada's updated forecasts claim that GDP will grow by 1.8% this year, 1.5% next year, and 2.5% in 2025, all amid expectations of a recession in the US.   Also, considering that the Canadian labor market has appeared more stable since the time of COVID restrictions, its recovery was faster than in the US. In general, the week is likely to end in the positive for the loonie, there are fewer factors that could turn the Canadian dollar's course towards weakening.   The net short position on CAD has been liquidated, weekly change +0.51 billion, a long position of 270 million has been formed. The positioning is neutral for now, but the trend is towards further demand for the Canadian dollar. The calculated price is noticeably lower than the long-term average.       USD/CAD continues to trade lower, although it has not yet managed to reach the target of 1.3040/60 outlined a week earlier. We expect the pair to fall further, the next target after passing the lower band of the channel will be the technical level of 1.30. USD/JPY The Bank of Japan published its latest regional economic report on July 10. One of the key topics is the comments by the leaders of the BoJ's regional offices regarding the pace of growth in average wages, which is key to understanding the BoJ's position on methods of responding to high inflation. Most of the reports indicate that there is a nationwide increase in average wages by around 5%, in some cases, it rises to 7%, as high inflation reduces real household incomes.   In May, the average wage across Japan grew by 2.5% YoY compared to 0.8% in April. At the same time, comments clearly trace the idea that changing the yield curve control policy means subjecting stability to unjustified risk. Nobody wants to take responsibility, and the question of whether practical steps will be taken at the July meeting remains open.   In regards to the yen exchange rate, this uncertainty does not compel us to expect the pair to strengthen. The net short position on the yen grew by 0.7 billion over the reporting week to -10.5 billion, positioning is confidently bearish. The calculated price is higher than the long-term average and is directed upwards. The yen sharply corrected, the main reason for the decline is the US dollar's weakness and the growth of the Japanese stock market, which continues to receive foreign capital in large volumes.  

JPY: Where is the alarm? USD/JPY has quietly drifted into the 145-150 intervention zone without triggering many alarm bells in Tokyo. One difference between now and the intervention period last September and October is that FX conditions are much more orderly. For example, one month USD/JPY implied volatility is trading near 9% today versus levels in the 14-15% region during Japanese FX intervention last year.  At the same time, there is no sense of a 'sell Japan' mentality emerging, and Japanese authorities may actually tolerate a softer yen given the deflationary forces emerging from China and the weak export markets in Asia and Europe. Unless we see some financial shock that triggers an unwind of the carry trade, it looks as though USD/JPY can hang around this 145/150 region longer than we had originally forecast. A decisive turn lower may have to wait until the late September and October period when more evidence of a US slowdown should have emerged and speculation will be growing over a Bank of Japan policy change at the meeting in late October.

EU and China Service PMIs drive global growth concerns UK Final Services PMI revised higher but downward trend remains Fed’s Waller (hawk) says “There is nothing that is saying we need to do anything imminent anytime soon.” GBP/USD (daily chart) as of Tuesday (9/5/2023) has made a quick and strong breakdown below multiple support levels, indicating a potential bearish breakdown could target the 38.2% Fibonacci level, which resides at 1.2072.  A bearish near-term outlook has been in place over the past month on the decline of both the longstanding bullish support trendline that was in place since last October and below the 50-day SMA.  Price action is currently trading below the 100-day SMA and if downside continues, could target the 200-day SMA at 1.2421. Upward UK PMI revisions The British pound pared losses this morning after UK services data came in better-than expected, outperforming what came from the Eurozone and following the downbeat readings from China.  The UK service sector is still in contraction territory, standing at 49.5, but it did buck the trend we saw with the rest of Europe. While the service reading was revised higher from a preliminary reading of 48.7, the downward trend that started in April remains firmly in place. Central bank expectations Slowing global growth concerns are sending rate hike expectations lower across the board.  Fed fund futures now are only pricing in a 6.8% chance of a rate hike at the September 20th meeting and the November 1st odds are currently at 37.2%. The ECB rate hike odds for the September 14th meeting are now at 25.5% and the October 26th meeting has a 25.8% expectation for a rate increase. Both the BOE and Riksbank are the only central banks (advanced economies) that are close to fully pricing in rate increases at their respective September policy decisions.  The BOE appears poised to deliver two quarter-point rate increases as financial markets price a 97.6% chance of an increase at the September 21st meeting. Short-term drivers The GBP/USD pair reacted positively to Fed’s Waller’s comment that the data doesn’t say we need to do anything imminent.  Waller is considered one of the more hawkish Fed members, so this comment could help convince markets that the Fed is likely done raising rates. It appears that global sentiment will likely be the primary driver here for the British pound, but dollar weakness could emerge if more Fed officials signal the end of tightening has arrived.  If the UK labor market starts to loosen and household spending softens, BOE rate hike odds could come down and that could also fuel further downward pressure on sterling.  

Are commodities on the verge of becoming the hottest topic in finance again, or will AI remain in focus? A year-long commodity sector correction showing signs of reversing The commodity sector looks set to start the third quarter on a firmer footing after months of weakness saw a partial reversal during June. Multiple developments, some based on expectations and some on actual developments, have all contributed to the strong gains, the most important being renewed dollar weakness as interest rate gaps narrow, OPEC’s active management of oil production and prices, the not-yet-realised prospect for the Chinese government stepping up its support for the economy and, not least, the risk of higher food prices into the autumn, as several key growing regions battle with hot and dry weather conditions.  Despite continued demand worries led by recession concerns in the US and Europe, the energy sector is holding up – supported by Saudi Arabia’s unilateral production cut, rising refinery margins into the peak summer demand season and speculative traders’ and investors’ belief in higher prices being near the weakest in more than ten years, thereby reducing the risk of additional aggressive macroeconomic-related selling. Elsewhere, we are seeing hot and dry weather raising concerns across the agriculture sector, while also raising demand for natural gas around the world from power generators towards cooling. The precious metal rally ran out of steam during the second quarter, as surging stock markets reduced the need for alternative investments while central banks continued to hike rates in order get inflation under control. Inflation may fall further but we increasingly see the risk of long-term inflation staying well above the 2% to 2.5% target area, and together with a growing bubble risk in stocks, continued strong demand from central banks, and the eventual peak in short-term rates as the FOMC shifts its focus, we see further upside for precious metals into the second half of the year. From the recent price performance across the different sectors, we could be seeing the first signs of markets bottoming out, with current levels already pricing in some of the worst-case growth scenarios. Data on the US economy is still showing economic activity below trend growth but is also not showing recession dynamics, and earnings estimates have increased substantially, especially in Europe, since the Q1 earnings season started in mid-April. The potential for additional gains from here, however, will primarily depend on whether China can deliver additional stimulus, thereby supporting demand for key commodities from crude oil to copper and iron ore. Weather developments across the coming weeks across the Northern Hemisphere and their impact on crop production will also be key. Gold pausing but a fresh record high remains the target Following a strong run-up in prices since November, gold spent most of the second quarter consolidating after briefly reaching a fresh record high. Sentiment is currently challenged by the recent stock market rally and the prospect for additional US rate hikes, thereby delaying the timing of a gold supportive peak in rates. So while the short-term outlook points to further consolidation below 2,000 dollars per ounce as we await incoming economic data, we keep an overall bullish outlook for gold and silver, driven among others by: continued dollar weakness; an economic slowdown, making current stock market gains untenable, leading to fresh safe-haven demand for precious metals; continued central bank demand providing a floor under the market; sticky US inflation struggling to reach the 2.5% long-term target set out by the US Federal Reserve (and if realised, it will likely to trigger a gold-supportive repricing of real yields lower), and a multipolar world raising the geopolitical temperature. In addition, silver may benefit from additional industrial metal strength, which could see it outperform gold. Overall, and based on the expectations and assumptions mentioned, we see the potential for gold reaching a fresh record high above $2100 before year-end.  

Japanese data improves but we still don’t expect a BoJ policy shift this month Although third-quarter GDP was revised down unexpectedly, the improved current account and cash earnings suggest a rebound in growth in the current quarter. Market speculation about the Bank of Japan's possible policy turnaround at the December meeting has been amplified after recent remarks from Governor Kazuo Ueda and Deputy Governor Ryozo Himino.   GDP contraction deepened in 3Q23 Third-quarter GDP was unexpectedly revised down to -0.7% quarter-on-quarter (seasonally adjusted) compared to the flash estimate and market consensus of -0.5%. The largest revision came from private consumption, which fell 0.2% (vs 0.0% in the flash estimate) and the inventory contribution to GDP, which was down by 0.2% ppt. The negative contribution of inventory should be a good sign for the inventory restocking cycle. But household spending still lagged amid high inflation despite relatively healthy labour market conditions, which should be a real concern for the Bank of Japan. We think that weaker-than-expected GDP could justify the Bank of Japan's current easing policy at least for now.   Meanwhile, GDP for the first quarter was revised up meaningfully from 0.9% to 1.2% resulting in an upward revision to annual GDP. Thus, now we expect 2023 GDP to rise 2.0% year-on-year.    However, other data releases today - labour cash earnings, household spending, and current account - point to a rebound in growth in the fourth quarter, thus we believe that the BoJ will shift its policy early next year.   Contraction deepened in 3Q23   Labour cash earnings rose in October Labour cash earnings rose 1.5% YoY in October (vs 1.2% in September, 1.0% market consensus) beating the market consensus. Contractual earnings gained steadily by 1.3% (vs 0.9% in September) while volatile bonus earnings (7.5%) rebounded after two months of declines. Also, hours worked bounced back 0.7% for the first time in four months, thus overall labour market conditions and earnings appear to have recovered in October. However, wage growth was still short of inflation growth, thus real earnings dropped 2.3% in October, although at a slower pace than the previous month's -2.9%.  Nominal wage growth continues and is clearly faster than the previous year. Also, there are several news reports that big companies plan to raise wages above this year's level of growth. Thus, we believe that next year's wage growth should accelerate a bit more than the current year.    Cash earnings and household spending improved in October   Current account surplus widened in October In a separate report, the current account surplus widened more than expected in October to JPY 2.6tn (vs 2.0 in September, 1.8 market consensus). Despite the global headwinds, the current account surplus will likely widen in the coming months. Due to falling commodity prices, the merchandise account will turn to surplus while an influx of foreign tourists will help the travel account to remain in surplus. We expect the trade of goods and services to improve in the current quarter.    Current account surplus in October led by service (travel)   BoJ preview Several remarks by the Bank of Japan, including Governor Ueda, have shaken the FX market quite strongly. Deputy Governor Himino said that ending the negative interest rate policy would have only a limited impact on the economy and Governor Ueda yesterday met with the prime minister, highlighting the importance of sustainable wage growth and inflation, which led to a fairly rapid shift in market sentiment betting on the Bank of Japan's policy tightening. Dollar weakness is also supporting the sudden move of the yen partially, especially ahead of today's release of the US nonfarm payrolls data.   It seems like the BoJ is paving the way to a gradual normalisation and giving the market a signal that the time is approaching. However, since these comments were made outside of the BoJ meeting, any sudden major change of policy is not expected this month. Yes, we remember that Governor Kuroda surprised the market with a yield curve control tweak last December, but we believe Governor Ueda is unlikely to adjust policy without prior communication. Thus, we expect some changes in the statement and dialogue from Governor Ueda at the BoJ meeting on 18-19 December.    As we have previously argued, we think the Bank of Japan's rate hike will come in 2Q24, most likely at its June meeting. By then, the BoJ will be able to confirm a solid wage increase with Shunto's results. In terms of inflation, it will trend down early next year, but still core inflation, excluding fresh food, is expected to remain above 2%. Even if the BoJ carries out a rate hike, we believe that the Bank's JGB buying operation will continue in order to avoid a rapid rise in long-term yields.