Inflation data in focus as last test for July Fed hike

USD: Dollar weakness reflects less conviction on Fed

The dollar weakness of late points to less conviction on a rate hike in July, but only slightly with market pricing still largely consistent with a 25bps rate hike on 26^th July. Data points have come and gone and while the PCE inflation and the payrolls report on Friday were on the weaker side of expectations, neither was enough to move the dial markedly on the probability of another rate hike this month. Still, another weaker data point today in the CPI report could be a catalyst for conviction levels on a hike to come down further. In that regard, the dollar could be vulnerable to further weakness into the FOMC meeting. We can’t ignore Fed communication in this and were it not for the largely consistent message of more hikes being needed, the data releases themselves would probably have taken market pricing down on a July rate hike.

In addition to the CPI release today we also have a heavy schedule of Fed speakers with Fed Presidents Barkin (non-voter); Kashkari (voter); Bostic (non-voter); and Mester (non-voter) all speaking today along with the release of the Beige Book with Fed Governor Waller closing out the speaking tomorrow before we enter the quiet period ahead of the FOMC meeting. New York Fed President Williams in the FT yesterday stated that the US had a “very strong labour market” and the data last week did not change that. He did admit his forecasts for growth were lowered although he does not expect a recession. It is hard to see much in the way of a change in rhetoric from today’s speakers and the communications are likely to be consistent with two hikes to come that will keep the rates market priced for more hikes.

The bigger risk to market pricing therefore must surely be from the data itself and the CPI data provides us with the greatest degree of detail on how the inflation picture is evolving. Base effects mean another large YoY headline drop is very likely (3.1% vs 4.0% previously) but the core rate is set to fall only from 5.3% to 5.0%.

The above chart shows the 3mth annualised rate of change in the core services, ex-housing measure that the Fed have been focusing on. The 3mth annualised rate remains elevated at 4.3%, although down from 4.8% in April and a peak of 5.1% in December. Another easing today could likely take that measure back to levels last seen in September of last year and would add credibility to the view of a more sustained slowdown in underlying inflation.

The dollar tends to perform poorly in the immediate period after the CPI data. In a 6-hour period following the data, the dollar has weakened in eight of the last ten months of CPI data releases with the data weaker than expected or in line with expectations in seven of those ten months. The hurdle for a surprise to the downside is becoming lower in the core readings given the sharp declines in headline CPI will soon be behind us and we believe there is scope for downside surprises given those sharp falls in headline inevitably feed into underlying inflation. If that were to be evident today we would expect further falls in US rates and the dollar albeit less than what we expected a few days ago given the dollar selling of late.

SUPERCORE CPI NEEDS TO SLOW TO PROMPT FOMC RHETORIC SHIFT

Source: Bloomberg, Macrobond & MUFG GMR

NZD & CAD: RBNZ holds, will the BoC follow?

The decision of the RBNZ today to keep its policy rate unchanged for the first time in the tightening cycle is no surprise and was flagged in advance with the acknowledgement by the RBNZ back in May that slowing demand and a surge in immigration would help bring inflation back to within its target range of 1.0% - 3.0% by next year. Back in May it also concluded that the policy rate would be on hold until Q3 2024 but the weakening housing market and broader economy will likely mean inflation comes down faster than the RBNZ is forecasting and hence the window for a rate cut will come sooner than it expects. Today the RBNZ said the policy rate would remain on hold for the “foreseeable future”. In our view a rate cut at the tail-end of the year or certainly in Q1 2024 seems likely. We expect that to result in NZD underperformance relative to the rest of G10. The feed-through of previous tightening will be part of the story in seeing inflation come down faster than expected. Indeed, the RBNZ admitted today that the impact of past tightening has yet to fully feed through to the housing market.

Rates in New Zealand are down sharply with the 2yr yield down 14bps – a larger drop than in 10yr highlighting a bull-steepening move that will leave NZD vulnerable to further underperformance. We maintain our long AUD/NZD trade view published in our FX Weekly (here).

The Bank of Canada decision later today is more finely balanced than the decision by the RBNZ earlier. After a long pause the BoC in June hiked again and market pricing implies a 75% probability of another hike today. US economic resilience, strong equity market performance and a strong jobs report from Canada last Friday will likely see the BoC hike this afternoon. We remain unconvinced of the need to move. Yes, the jobs market was strong (59.9k increase in employment vs 20k expected) but wage inflation was weak with the hourly wage YoY rate falling from 5.1% to 3.9%. Does the BoC need to hike with the core Median YoY CPI rate down at 3.9% with further tightening still to feed into the real economy?

Any benefit today for CAD from a rate hike is unlikely to be sustained over the medium term. We now forecast little change in USD/CAD through to year-end even as the dollar weakens across G10 and then see USD/CAD higher in 2024 as economic weakness is more pronounced in Canada than elsewhere.

AUD/NZD SET TO BOUNCE HIGHER AS RBNZ PAUSES

Source: Macrobond

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
UK	09:00	BoE Gov Bailey Speaks	--	--	--	!!!
US	12:00	MBA Mortgage Applications (WoW)	--	--	-4.4%	!
US	13:30	Fed's Barkin speaks				!!!
US	13:30	Core CPI (MoM)	Jun	0.3%	0.4%	!!!!!
US	13:30	Core CPI (YoY)	Jun	5.0%	5.3%	!!!!!
US	13:30	CPI (MoM)	Jun	0.3%	0.1%	!!!!!
US	13:30	CPI (YoY)	Jun	3.1%	4.0%	!!!!!
US	13:30	Real Earnings (MoM)	Jun	-0.1%	-0.1%	!
US	14:45	FOMC Member Kashkari Speaks	--	--	--	!!!
EC	14:45	ECB's Lane Speaks	--	--	--	!!!
CA	15:00	BoC Monetary Policy Report	--	--	--	!!!!
CA	15:00	BoC Rate Statement	--	--	--	!!!!
CA	15:00	BoC Interest Rate Decision	--	5.00%	4.75%	!!!!!
US	16:00	Cleveland CPI (MoM)	Jun	0.4%	0.4%	!!
CA	16:00	BOC Press Conference	--	--	--	!!!!
US	18:00	Fed's Bostic speaks				!!!
US	19:00	Beige Book	--	--	--	!!
US	21:00	FOMC Member Mester Speaks	--	--	--	!!!

Source: Bloomberg