Disinflation evidence keeps USD under selling pressure

USD: PPI adds to disinflation evidence

The swing in the 2-year UST note yield from the high last Thursday to the low yesterday was 50bps which technically certainly paints a negative picture given last Thursday’s high was a new cyclical high for the 2-year yield. The reversal is a strong rejection for the second time of yields over 5.00%. The data from the US continues to back up this rejection of higher yields and the PPI data yesterday revealed that prices at the factory gate are close to turning to deflation. Final Demand PPI on an annual basis gained just 0.1% in June while core PPI was weaker than expected at 2.4% (exp 2.6%). Food prices were -0.1% m/m; goods prices were 0.0% m/m and core goods prices fell outright as well at -0.2%. It adds to the evidence that the Fed’s battle on bringing inflation back to target is close to won.

The more compelling inflation data this week doesn’t appear to have altered the view of key Fed officials however. Governor Waller in a speech yesterday stated very clearly that he saw two further 25bp hikes over the final four meetings of this year as required to “keep inflation moving toward our target”. That really doesn’t make much sense to us given the known lags in delivering monetary policy changes and Waller’s argument that inflation slowed in the summer of 2021 before picking up again isn’t really a justifiable comparison to keep hiking either. Russia’s invasion of Ukraine caused the reacceleration implying Waller believes the Fed should keep tightening in case we have another inflation shock. Still, he was clear that he saw no reason why the first of those two hikes should not occur at the July meeting.  

The 2-year yield hence is being driven more by what the market is now pricing further out the curve. Since 6^th July, the OIS market has priced in 40bps of rate cuts (55bps now vs 15bps) by June 2024 and this reflects the Fed’s rhetoric of effectively wanting to carry on hiking despite the compelling evidence of larger than expected disinflation.

The DXY index fell back below the 100-level yesterday for the first time since April 2022 and we are now close to fully reversing the USD surge fuelled by the Fed’s dramatic hawkish shift last year when central bank officials and investors realised the scale of the inflation shock at hand. Ove the last 10yrs, DXY has tended to remain within a 90-100 range and we suspect we are returning back into that more normal trading range as the global inflation shock recedes.

DXY RETURNING TO THE 90-100 DXY RANGE

Source: Bloomberg, Macrobond & MUFG GMR

GBP:  Maintaining top performer status

The pound was the top performing G10 currency in Q1 and Q2 and even though it has strengthened by a further 3% this month, it is lagging amongst G10 currencies in July as other under-performing currencies play catch-up as the US dollar weakens more broadly. On a year-to-date basis the pound remains the top performing G10 currency but the lagging performance in July may be an early sign that investors are possibly becoming more cautious over the scale of further appreciation from here.

In the current scale of USD selling, now is not the time to argue for this move to reverse but we remain wary of the extent of ongoing appreciation of the pound. The scale of tightening priced into the UK curve reflects the much worse inflation backdrop but the speed of turnaround in the US inflation risks does serve as a possible example of what could unfold here at some stage. Inflation is still set to fall sharply with utility bills and food prices set to slow. The BoE certainly has more work to do (we think two more 25bp hike in Aug & Sept) but there remains close to 120bps of tightening priced through to January 2024 and based on the incoming data and falling inflation globally, this continues to look excessive. 

GDP data yesterday declined by less than expected (-0.1% m/m vs -0.3% expected in May) and while the extra holiday for the King’s coronation weighed on growth, the fewer number of strike days helped support growth. Essentially, the UK economy continues to stagnate.

That is unlikely to change dramatically over the coming quarters with the improvement in real incomes (OFGEM utility price cut and as inflation falls generally) offset by the increased impact of the lagged effects of monetary tightening.

The RICS housing report was also released yesterday and the main House Price Balance Index fell to a new cyclical low of -46.45, the weakest reading since April 2009 in the depths of the Global Financial Crisis. The Rightmove House Price Index data will be released on Monday and further price declines are likely. The lagged impact on housing due to over 80% of the market being on fixed as rates began to rise means a further hit to consumer sentiment is likely. September is one of the largest months of the year for fixed mortgages re-setting and hence the lagged impact of monetary tightening could well become more apparent in the Autumn. That may see market participants readjust rate hike expectations which could result in renewed GBP underperformance.

UK HOUSE PRICES SET TO FALL FURTHER

Source: Macrobond

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
IT	09:00	Italian Trade Balance	May	1.450B	0.318B	!
IT	09:00	Italian Trade Balance EU	May	--	-0.92B	!
EC	10:00	Trade Balance	May	-7.6B	-11.7B	!
US	13:30	Export Price Index (MoM)	Jun	-0.3%	-1.9%	!
US	13:30	Export Price Index (YoY)	--	-11.1%	-10.1%	!
US	13:30	Import Price Index (MoM)	Jun	-0.1%	-0.6%	!
US	13:30	Import Price Index (YoY)	--	-3.6%	-5.9%	!
CA	13:30	Manufacturing Sales (MoM)	May	0.8%	0.3%	!
US	15:00	Michigan 5-Year Inflation Expectations	Jul	3.1%	3.0%	!!!!
US	15:00	Michigan Consumer Expectations	Jul	61.8	61.5	!!
US	15:00	Michigan Consumer Sentiment	Jul	65.5	64.4	!!
US	15:00	Michigan Current Conditions	Jul	70.4	69.0	!!
US	15:00	Michigan Inflation Expectations	Jul	3.3%	3.3%	!!!!

Source: Bloomberg