Dollar Knee-Capped by the Fed Whisperer

September 13, 2024

Win Thin

The so-called Fed whisperer has struck again; August PPI was a non-event; University of Michigan reports preliminary September consumer sentiment; growth remains robust in Q3
ECB cut rates as expected; updated macro forecasts were largely unchanged; Lagarde offered no forward-looking policy hints in her press conference; unnamed ECB officials later said that an October cut has not been ruled out; eurozone reported soft July IP data; BOE August inflation expectations survey was mixed
The yen is making new highs for this move ahead of the BOJ meeting next week; China reports August real sector data will be reported Saturday local time

The dollar remains under pressure as Fed easing expectations are shaken up. DXY is trading lower for the second straight day near 101 after a WSJ story by the so-called “Fed whisperer” (see below). The yen is outperforming even as BOJ expectations remain dovish (see below), with USD/JPY trading at a new cycle low today near 140.35. The euro is trading higher near $1.1090 after the ECB decision (see below), while sterling is trading flat near $1.3130. 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 support our call for Fed cautiousness but we have to acknowledge heightened risks of a dovish surprise from the Fed next week (see below).

AMERICAS

The so-called Fed whisperer has struck again. U.S. rates expectations adjusted sharply lower overnight after Wall Street Journal reporter Nick Timiraos wrote that next week’s Fed decision would be a close call. The full story can be found here. We continue to look for a 25 bp cut next week but the WSJ story suggests there are significant risks to a dovish surprise. Odds of a 50 bp cut next week have risen sharply from about 10% after the PPI data yesterday to nearly 50% now, while nearly 125 bp of total easing is seen by year-end. The market is also back to pricing in nearly 250 bp of total easing over the next 12 months. The timing of the story is odd, coming at a time when a 25 bp cut had become baked in the cake due to the inflation data.

Indeed, August PPI was a non-event. Headline came in as expected at 1.7% y/y vs. a revised 2.1% (was 2.2%) in July, while core came in as expected at 2.4% y/y vs. a revised 2.3% (was 2.4%) in July. The m/m gains came in a tick higher than expected but were offset by downward revisions to the July m/m gains. Final demand ex-trade, transport, and warehousing, which is an input for PCE calculation, eased a tick to 4.2% y/y. In that regard, the Cleveland Fed’s Nowcast model still sees August headline and core PCE at 2.3% and 2.8%, respectively.

University of Michigan reports preliminary September consumer sentiment. Headline is expected at 68.5 vs. 67.9 in August. While down from the March high of 79.4, this would represent a four-month high that’s consistent with healthy consumer spending activity. Both current conditions and expectations are expected to improve to 61.6 and 72.2, respectively. With gas prices and mortgage rates continuing to fall, we expect consumer confidence to continue improving. Lastly, the survey’s inflation expectations are expected to remain steady, with 1-year at 2.8% and 5- to 10-year at 3.0%.

Growth remains robust in Q3. The New York Fed’s Nowcast model is tracking Q3 growth at 2.6% SAAR and Q4 growth at 2.2% SAAR. Both estimates will be updated today. Elsewhere, the Atlanta Fed’s GDPNow model tracking Q3 growth at 2.5% SAAR, up from 2.1% previously. It will be updated next Tuesday after the data.

EUROPE/MIDDLE EAST/AFRICA

The ECB cut the key deposit facility rate (DFR) 25 bp to 3.50%. it also slashed the rates on its main refinancing operations (MRO) and marginal lending facility (MLF) by 60 bp to 3.65% and 3.90%, respectively. The aim is to improve liquidity condition and steer short-term money market rates closer to the DFR. As we expected, the ECB maintained its cautious easing guidance and reiterated 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.

Its updated macro forecasts were largely unchanged. It made no changes to its headline CPI inflation forecasts, while its core inflation projections for 2024 and 2025 were revised one tick higher even as the ECB still expects its to reach 2% in 2026. Real GDP growth projection were revised one tick lower across the forecast horizon. Bottom line: the ECB decision is unlikely to move the needle much on interest rate expectations, which is neutral for EUR.

ECB President Lagarde offered no forward-looking policy hints in her press conference. Lagarde confirmed the decision to cut the deposit facility rate was unanimous. Recall that at the June 6 meeting, one ECB governing council member (Robert Holzmann) objected to the cut. Lagarde also warned again that risks to economic growth are tilted to the downside.

Unnamed ECB officials later said that an October cut has not been ruled out. Despite the unanimous decision to cut, it's clear that the doves were not happy with the hawkish communication and took to the airwaves. We've seen this time and time again from both the hawks and the doves. Today, we got some more dovish comments as ECB Governing Council member Simkus noted this morning that Eurozone inflation is “calming down” and “its trajectory suggests that further rate cuts must happen.” Even noted hawk and ECB Governing Council member Nagel added “the inflation outlook is very good,” implying more rate cuts in the pipeline. Of note, the market sees 45% odds of an October cut but let's see how the data come in between now and October 17. We believe that the bar for additional ECB easing remains low. Of note, the swaps market now sees the policy rate bottoming at 1.75% over the next two years vs. 2.0% right after yesterday’s decision.

Eurozone reported soft July IP data. IP came in as expected at -0.3% m/m vs. a revised flat (was -0.1%) in June, while the y/y rate came in at -2.2% y/y vs. -2.3% expected and a revised -4.1% (was -3.9%) in June. We believe the weak economic outlook warrants the more dovish market pricing for ECB rate cuts.

Bank of England August inflation expectations survey was mixed. Expectations for the most part continued to fall, albeit slowly. As such, this should reinforce the BOE’s cautious approach to easing. 1-year expectations fell a tick to 2.7%, 2-year expectations were steady at 2.6%, 5-year expectations rose a tick to 3.2%.

ASIA

The yen is making new highs for this move ahead of the Bank of Japan meeting next week. Expectations for a hike are nearly zero, and the market does not price in the next hike until well into 2025, with only 25 bp of tightening seen over the next 12 months. Instead, the move in USD/JPY to 140.35 today is all coming from the U.S. side, as the 2-year UST yield sinks and differentials fall to new cycle lows.

China reports August real sector data will be reported Saturday local time. IP is expected at 4.6% y/y vs. 5.1% in July, sales are expected at 2.5% y/y vs. 2.7% in July, FAI is expected at 3.5% YTD vs. 3.6% in July, and property investment is expected at -10.0% YTD vs. -10.2% in July. China will be on holiday Monday and Tuesday.

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