Will US CPI report provide another setback for the USD?

USD: Oil price rebound continues ahead of US CPI report release

The main foreign exchange rates have remained stable during the Asian trading session with USD/CNY continuing to trade just below the 7.3000-level and USD/JPY at just below 147.50. The verbal intervention from domestic policymakers in China and Japan to support their currencies has at least helped to stable their currencies close to recent lows although is unlikely  to trigger a more sustained reversal of US dollar strength on its own. Market attention will shift back to the global inflation outlook today when the latest US CPI report for August will be released. The  recent rebound in the price of oil and gasoline has continued at the start of this week which if sustained would create a more challenging backdrop for central banks next year in their ongoing efforts to bring inflation back down to their targets. The price of Brent crude oil rose further above USD92/barrel overnight extending its advance since the low last month to almost 13% and to almost 30% since the low from back in June. The latest data published by OPEC showed that global markets face a supply shortfall of more than 3 million barrels a day in Q4. If realized it could be the biggest inventory drawdown since at least 2007 according to Bloomberg. OPEC’s 13 members have pumped an average of 27.4 million barrels per day so far this quarter or roughly 1.8 million less than it believes consumers needed. This gap between OPEC supply and demand is expected to almost double in Q4 when it estimates it will need to provide 30.7 million barrels a day to satisfy demand. Saudi Arabia’s recent decision to extend production cuts until the end of this year means that OPEC supply is expected to remain stable. The developments are encouraging speculation that the price of oil could rise back above USD100/barrel by the end of this year. A negative development for global consumers and would limit room for central banks to reverse policy tightening in the year ahead.

The higher price of oil could already be starting to have an influence on Fed rate expectations for next year. The amount of rate cuts priced in by December of next year has been pared back to around -83bps. If the Fed is encouraged to keep rates on hold for longer it would pose upside risks for our US dollar forecasts (click here). In our latest monthly FX Outlook report we pushed back our forecasts for further Us dollar weakness and the start of Fed rate cuts into 1H of next year.  Bringing developments back to today, the release of the US CPI for August is expected to reveal a pick-up in headline inflation (+0.6M/M) while core inflation is expected to increase at a slower pace (+0.2%M/M) for the third consecutive month. The recent faster than expected slowdown in inflation, employment and wage growth has reinforced market expectations that the Fed will leave rates on hold this month. There are currently only 2bps of hikes priced in for the 20^th September FOMC meeting. There would have to be a significant upside for inflation today to alter market expectations for the Fed to remain on hold. Looking at price action around CPI report releases this year, the dollar index has weakened in the first 30 minutes after releases following the last six CPI reports.     

YIELD SPREADS ARE STARTING TO MOVE AGAINST GBP

Source: Bloomberg, Macrobond & MUFG Research calculations

GBP:  Paring back of BoE hike expectations encouraging reversal of GBP gains

The pound has continued to trade at weaker levels overnight after selling off yesterday following the release of the latest labour market report from the UK. It has resulted in EUR/GBP rising back above the 0.8600-level while cable is continuing to hold just above support from the 200-day moving average that comes in at around 1.2430. The pound has been undermined recently by the paring back of BoE rate hike expectations as we highlighted in our latest FX Weekly report (click here). The UK rate market has become less confident that the BoE will deliver multiple further rate hikes in the current tightening cycle. There are 19bps of hikes priced in for next week’s MPC meeting and 39bps of hikes by February of next year. It implies that the UK rate market is currently attaching around a 50:50 probability to the BoE delivering one final hike after next week’s 25bp hike which is viewed as almost a one deal. The main trigger for the paring back of BoE rate hike expectations have been comments from BoE officials including Governor Bailey and Chief Economist Pill who have signalled that the rate hike cycle is close to an end and that keeping rates higher for longer is preferred to the alternative of hiking rates further towards 6.00%. Next week’s updated forward guidance from the MPC meeting will be important in determining whether the BoE plans to deliver one final hike or is becoming more confident that it has raised rates enough.

At the same time the recent data flow from the UK is helping to dampen BoE rate hike expectations as well. While yesterday’s labour market report did show average weekly earnings hitting a new high of 8.5% in July, the details of the report provided more encouragement that labour demand continues to weaken and wage growth is beginning to slow. Employment dropped by 207k and the unemployment rate ticked up further to 4.3% as  it moved further above the cycle low of 3.5% from las August. Back in the August MPR the BoE had forecast the unemployment rate would rise to only 4.4% by the end of next year.  Job vacancies also continued to fall and moved below 1 million. After stripping out more volatile bonuses, regular pay growth in the private sector has slowed in recent months coming. The HMRC’s median pay measure even declined by -0.5%M/M suggesting the peak has been reached for pay growth. Furthermore, it has just been revealed that services sector growth was much weaker than expected at the start of Q3. After expanding by 0.5%M/M in June, service sector output contracted by -0.5% in July. It has reinforced the pound’s downward momentum.

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:00	Industrial Production (MoM)	Jul	-0.7%	0.5%	!!
UK	12:00	NIESR GDP Estimate	--	--	0.3%	!!
US	13:30	Core CPI (MoM)	Aug	0.2%	0.2%	!!!
US	13:30	CPI (MoM)	Aug	0.6%	0.2%	!!!
UK	14:15	BoE Deputy Governor Woods Speaks	--	--	--	!!

 

Source: Bloomberg