Dollar Firm Ahead of ECB Decision

September 12, 2024

Win Thin

August CPI data painted a mixed picture; we think a 25 bp cut next week is now baked in the cake; PPI will be today’s highlight; weekly jobless claims will also command attention; Peru is expected to cut rates 25 bp to 5.25%
The ECB decision today should bring rate cuts and some operational tweaks; we expect the ECB to maintain its cautious easing guidance; Sweden reported soft August CPI data
BOJ board member Tamura was hawkish; Japan Q3 BSI survey came in firm

The dollar remains firm ahead of the ECB decision. DXY is trading higher for the fifth straight day near 101.730 and remains on track to test the September high near 101.917. Break above 102.191 is needed to set up a test of the mid-August high near 103.227. The yen is underperforming despite some more hawkish BOJ comments (see below), with USD/JPY trading higher near 142.75. The euro is trading slightly higher near $1.1020 ahead of the ECB decision due out shortly (see below), while sterling is trading higher near $1.3055. MXN is outperforming for the second straight day after passage of the judicial reforms. While the U.S. labor market is weakening, it is by no means weak and so we continue to believe that market expectations for aggressive Fed easing remain overdone (see below). The dollar’s recent resilience is encouraging but the fundamental data will have to come in firm in order for the greenback to see further gains. This week’s inflation data have taken on greater importance and the CPI readings support our call for Fed cautiousness (see below). All eyes are now on PPI today.

AMERICAS

August CPI data painted a mixed picture. Headline came in as expected at 2.5% y/y vs. 2.9% in July, while core came in as expected and remained steady at 3.2% y/y. However, OER picked up a tick to 5.4% y/y while super core was steady at 4.5% y/y. Headline was the lowest since February 2021 and while ongoing disinflation is encouraging for Fed officials, the details argue for caution on their part. Looking ahead to September, the Cleveland Fed’s Nowcast model sees headline and core at 2.3% and 3.1%, respectively.

We think a 25 bp cut next week is now baked in the cake. After the CPI data, odds of a 50 bp cut have fallen to 10-15%. The market is pricing in 100 bp of easing by year-end and 225 bp of easing over the next 12 months, both down by 25 bp after the data.

Financial conditions continue to loosen. The Chicago Fed’s weekly measure has loosened four straight weeks through last Friday and are the loosest since mid-November 2021, several months before the Fed started hiking rates. The Fed will be happy that the markets are doing some of the heavy lifting even before the easing cycle actually begins. We expect conditions to continue loosening after the Fed embarks on its easing cycle next week.

PPI will be today’s highlight. Headline is expected at 1.7% y/y vs. 2.2% in July, while core is expected to remain steady at 2.4% y/y. Keep an eye on PPI ex-trade, transportation, and warehousing as it is an input for PCE calculations. In that regard, the Cleveland Fed’s Nowcast model sees August headline and core PCE at 2.3% and 2.8%, respectively, but is clearly subject to change after the PPI data.

Weekly jobless claims will also command attention. Initial claims are expected to remain steady at 227k. if so, the 4-week moving average would also remain roughly unchanged at 230k, which is the lowest since early June. Of note, next week’s initial claims data will be for the BLS survey week containing the 12th of the month. Elsewhere, continuing claims are expected at 1.850 mln vs. 1.838 mln last week, which was the lowest since mid-June. There is no Bloomberg consensus yet for September NFP but its whisper number stands at 135k vs. 142k in August. From what we can tell, the labor market remains in solid shape.

Peru central bank is expected to cut rates 25 bp to 5.25%. At the last meeting August 8, the bank delivered a dovish surprise and cut rates 25 bp to 5.5% whilst noting that “Core inflation in July showed less persistence than in previous months.” The bank’s chief economist predicted that growth was 2.7% in H1 and did not rule out further cuts. Since then, both headline and core inflation have continued falling and this will allow the bank to continue cutting rates through much of next year.

EUROPE/MIDDLE EAST/AFRICA

The ECB decision today should bring rate cuts and some operational tweaks. The ECB is widely seen cutting the key deposit facility rate (DFR) 25 bp to 3.50%. The ECB is also expected to slash the rates on its main refinancing operations (MRO) and marginal lending facility (MLF) by 60 bp to 3.65% and 3.90%, respectively. This would be in line with the changes to its operational framework for implementing monetary policy announced in March. Specifically, the ECB wants to narrow the MRO-DFR spread from 50 bp currently to 15 bp and to keep the MRO-MLF spread at 25 bp. The narrower MRO-DFR spread is aimed at improving liquidity condition and steer short-term money market rates closer to the ECB's monetary policy decisions.

We expect the ECB to maintain its cautious easing guidance. It has said that “It will keep policy rates sufficiently restrictive for as long as necessary” and “follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction.” The updated macroeconomic projection will likely offer better policy guidance. Inflation is tracking the ECB projections. However, sluggish eurozone economic activity suggests the risk is the ECB tweaks lower its inflation and growth forecasts. This can lead to a downward adjustment to eurozone interest rate expectations, which would weigh on EUR.

Sweden reported soft August CPI data. Headline came in two ticks lower than expected at 1.9% y/y vs. 2.6% in July, CPIF came in two ticks lower than expected at 1.2% y/y vs. 1.7% in July, and CPIF ex-energy came in as expected and was steady at 2.2% y/y. CPIF was the lowest since December 2020 and moves further below the 2% target. The disinflationary backdrop supports Riksbank Governor Thedeen’s expectations for “three additional cuts” by December and raises the risk of four cuts. Indeed, the swaps market is pricing in nearly four cuts by year-end, followed by another three in H1 2025 that would take the policy rate down to 1.75%.

ASIA

Bank of Japan board member Tamura was hawkish. He said that “I believe that we need to raise the short-term rate to at least around 1% in the second half of the bank’s projection period through fiscal 2026. That’s needed to contain upside price risks and for achieving the stable and sustainable inflation target.” This implies about 75 bp of tightening over the next 24 months, which is less than the 35-40 bp that is currently priced in by the swaps market. However, he added that “I don’t have any preconception about the pace of rate hikes, as it depends on the economy, inflation and financial conditions. But unlike in the US and Europe, it’s likely to be a gradual one.”

We doubt the BOJ will tighten more than what the market has priced in. Simply put, Japan underlying price pressures remain low. Indeed, PPI inflation cooled more than expected to 2.5% y/y in August and is a downside risk to CPI inflation going forward as lower input cost for firms should translate to lower prices for consumers. Bottom line: JPY upside is limited.

Japan Q3 BSI survey came in firm. Large all industry business conditions came in at 5.1 vs. 0.4 in Q2 and was the biggest quarterly increase since Q3 2023. Large manufacturing conditions came in at 4.5 vs. -1.0 in Q2. Business conditions have improved in recent quarters, but headwinds are building as all industry large firms outlook fell to 4.7 vs. 7.2 previously.

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