• Financial markets appear to be unwinding the so-called “Trump trade” after the debate; August CPI data take center stage; Fed easing expectations have intensified; Mexico’s Senate passed AMLO’s judicial reforms
  
• Tomorrow’s ECB decision should bring some operational tweaks; the ECB will maintain its cautious easing guidance; U.K. reported soft July real sector activity; Bank of Israel releases its minutes
  
• BOJ board member Nakagawa sounded hawkish; RBA Assistant Governor Hunter spoke about Australia’s labor market

The dollar is soft as the Trump trade unravels after last night’s presidential debate (see below). DXY is trading modestly lower near 101.437 after three straight up days. The yen is back to outperforming after some hawkish BOJ comments (see below), with USD/JPY trading lower near 141.50. The euro is trading higher near $1.1045 ahead of tomorrow’s ECB decision (see below), while sterling is trading flat near $1.3080 after soft real sector data (see below). MXN is outperforming despite passage of the judicial reforms (see below). 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 all eyes are on CPI today.

AMERICAS

Financial markets appear to be unwinding the so-called “Trump trade” after the debate. While it’s too soon for updated polling data, the initial reaction in the betting markets suggests Vice President Harris won last night’s debate against former President Trump. Furthermore, the current financial market reaction is the exact opposite of the post-June presidential debate response, when Trump emerged as the clear winner against President Biden. Following the June 27 debate, the dollar firmed slightly, U.S. Treasury yields rose, and U.S. stocks rallied. The macroeconomic logic is that fiscal and trade policies under a Trump presidency are inflationary, forcing the Fed to keep policy restrictive for longer. That said, we believe U.S. economic outperformance will continue to support the dollar.

August CPI data take center stage. Headline is expected at 2.5% y/y vs. 2.9% in July, while core is expected to remain steady at 3.2% y/y. The increase in the ISM services and manufacturing prices paid indexes point to upside risks. Keep an eye on super core, which remains elevated at 4.5% y/y. That said, the progress on inflation is encouraging and Fed officials are clearly more concerned with downside risks to employment than upside risks to inflation. The Cleveland Fed’s Nowcast model sees headline and core at 2.6% and 3.2%, respectively. For September, the model sees headline and core at 2.3% and 3.1%, respectively.

Fed easing expectations have intensified. The odds of a 50 bp cut this month remain stuck around 30%. However, the market is now pricing in nearly 250 bp of easing over the next 12 months, the high for this cycle. If so, that would take the Fed Funds rate down to just below 3.0%, which is what many view as the neutral rate r*. That means the market is expecting the Fed to move from restrictive to just below neutral over the course of 12 months. To us, that seems highly unlikely given the economic data to date but obviously, the market has other ideas. Perhaps today’s CPI data will change some minds.

Mexico’s Senate passed AMLO’s judicial reforms. The vote was 86-41 and the decisive vote came from opposition PAN Senator Miguel Angel Yunes Marquez, who switched sides to vote in favor of the proposal. While some changes to the reforms could still be proposed, the main plank was passed. That is, all federal judges will be elected by popular vote. With AMLO’s Morena party dominating the recent national elections, many fear that AMLO’s successor Scheinbaum will enjoy unchecked power. The peso is firmer today but that seems to be due more to the unravelling of the Trump trade rather than passage of the judicial reforms. We expect the peso to resume underperforming once the judicial reforms are fully digested. Stay tuned.

EUROPE/MIDDLE EAST/AFRICA

Tomorrow’s ECB decision should bring 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.

U.K. reported soft July real sector activity. GDP came in flat m/m for the second straight month vs. 0.2% expected, IP fell -0.8% m/m vs. 0.3% expected and 0.8% in July, services came in a tick lower than expected at 0.1% m/m vs. -0.1% in June, and construction fell -0.4% m/m vs. 0.5% expected and actual in June. The y/y rates improved modestly due to low base effects from last year. Nevertheless, leading indicators point to a pickup in U.K. economic activity and suggests the Bank of England is unlikely to cut rates by more than is currently priced in (50 bp by year-end), which should offer GBP some support.

Bank of Israel releases its minutes. At that meeting August 28, the bank kept rates steady and Deputy Governor Abir noted “I would be very surprised if the conditions are in place for an interest rate cut before the end of the year. The surprise has been how long the war has been going on. This has slowed growth but has also had an impact on inflation, and it’s one of the reasons it is now once again out of our target range.” Next meeting is October 9 and no change is expected then. Despite the hawkish hold, the swaps market is still pricing in 50 bp of total easing over the next 12 months.

ASIA

Bank of Japan board member Nakagawa sounded hawkish. Nakagawa stuck to the bank’s hawkish guidance that “the degree of monetary easing will be adjusted if the outlook for Japan’s economy and inflation is realized.” She added that “the current level of real rates is extremely low,” suggesting the BOJ has room to crank up the tightening cycle. Indeed, the real policy rate is negative at around -2.7%. Still, we doubt the BOJ will tighten more than is currently priced and this should limit JPY upside momentum. The market does not price in the next hike until well into 2025, with only 20-25 bp of tightening seen over the next 12 months. Tamura speaks tomorrow.

RBA Assistant Governor Hunter spoke about Australia’s labor market. Hunter pointed out that “the labor market is still tight relative to full employment” and stressed that the RBA’s view is that “further falls in vacancies can still occur alongside a relatively modest increase in the unemployment rate.” The comments support the RBA’s case against near-term policy rate cuts. However, we expect the RBA to join the global easing cycle later this year because Australia underlying economic activity is weak and points to lower inflation pressures. The likelihood of a dovish RBA pivot is a drag for AUD.