Today’s Battle: Soft US CPI vs Stretched Momentum Indicators and Two Fed Cuts Discounted

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Marc Chandler
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Overview: The focus today is on the US CPI report. Another soft reading is expected, and it may strengthen ideas of a Fed cut in September, which ostensibly gives it time to cut again before the end of the year. The dollar is trading with a softer bias against most of the G10 currencies. A stronger than expected May GDP report helped sterling reach new four month high. The greenback is also holding below yesterday's high near JPY161.80 against the Japanese yen. The euro briefly traded above $1.0850 for the first time in almost a month. The intraday momentum indicators for the dollar, warning that follow-through losses may be limited. Most emerging market currencies are firmer, including the Chinese yuan. The three notable exceptions are Türkiye, Mexico, and India, which are nursing small losses. 

Chinese officials are making it more difficult to short equities and Chinese stocks responded accordingly, with the major indices rallying more than 1%. Most equity markets in the region, but India rose today. Europe's Stoxx 600 is extending yesterday's 0.9% gain with another 0.5% increase today and is now higher for the week. Us index futures are slightly softer. European benchmark yields are narrowly mixed. The French premium over Germany has narrowed slightly. After a well-received auction yesterday, the US 10-year yield is a little lower, trading below 4.28%. Gold held support near $2350 earlier this week and is trading with a firmer bias near $2382. The week's high from Monday was slightly above $2390. September WTI initially extended yesterday's recover from $80 to reach almost $82 today but stalled and is near session lows a little above $81. 

Asia Pacific

Yesterday's 0.2% rise in Japan's PPI for a 2.9% year-over-year rate, the highest since last August, had little impact on Japanese rates and did not benefit the yen one iota. Still, the 2.2% decline in the yen and rise in oil prices did it no favors. The focus is on the month-end BOJ meeting. The swaps market has discounted about a 60% chance of a 10 bp hike, while the BOJ heard from banks about its bond purchases. A plan for reducing its buying from around JPY6 trillion (~$6.2 bln) is widely expected. Any slowing will signal the beginning of QT. Meanwhile, the US announced 25% tariffs on steel arriving from Mexico that was not melted or poured in the USMCA. A 10% tariff levied on aluminum from China, Russia, Iran, or Belarus. Lastly, note that China is reportedly holding joint military exercises with Belarus near Poland on the eve of the NATO summit, while Japan announced it was hosting joint military exercises with Germany and Spain near Hokkaido. 

Even without the encouragement from higher US Treasury yields, the dollar crept higher against the yen yesterday and reached almost JPY161.85. It is in about a quarter of a yen range above JPY161.50 today. The lack of verbal intervention by Japanese officials is somewhat surprising, though net-net the dollar is flattish since settling near JPY161.70 last Wednesday. Still, one must suspect this is intentional and allows a greater chance of surprise. A drop in US yields after today's CPI may take some pressure off the yen, but if it does not, intervention could be justified ostensibly on ground of the exchange rate not reflecting fundamentals. The Australian dollar has gone nowhere. It has settled within a few hundredths of a cent around $0.6740 for four consecutive sessions. The Aussie is trading firmly near its best level since early January. The momentum indicators are stretched but have not turned down. The next important Australian data point is now until next Thursday's June employment report. We suspect a pullback before that will be bought as a strong employment report would underscore the risk of an RBA rate hike later this year. There are options for almost A$480 mln at $0.6760 that expire today, which it is flirting with in the European morning. The Chinese yuan is having its best day in nearly a month. It is up about 0.12% against the greenback. It is the first gain in three days. Officials have moved to stabilize the equity market by raising the margin for short sales (as of July 22) and the biggest lender of shares, China Securities Finance Corp, will suspend lending shares as of today. Today's fix was at CNY7.1339 (CNY7.1342 yesterday). Against the offshore yuan, the dollar has eased to a new low for the week near CNH7.28. It has not been below there since June 18. 

Europe

After stagnating in April, the UK economy grew by 0.4% in May, twice the median expectation in Bloomberg's survey. The growth was broad based. Industrial output missed expectations of a 0.3% increase by rising 0.2%, after falling by 0.9% in April. Manufacturing rose by 0.4%. It has fallen by -1.4% in May. Construction output jumped by 1.9%, nearly three times more than expected after a revised 1.1% decline (from -1.4%). Net exports also improved, and the trade deficit fell (GBP4.89 bln vs GBP6.43 bln). The index of services showed another 0.3% increase, matching the revised rise in April (from 0.2%). Recall that the monthly GDP prints in Q1 summed to 0.9% but the quarterly growth was 0.7%. The BOE projects 0.5% Q2 GDP. The Office for National Statistics had blamed April's stagnation on the weather and suggested better weather in May could have lifted the economy. The Bank of England meets on August 1. Expectations for a BOE rate cut eased slightly yesterday after the central bank's chief economist expressed concern about the persistence of inflation. The odds of a cut slipped in the swaps market to about 56% from 64% on Tuesday. It has eased to about 52% after the GDP figures. This is the lowest since the last BOE meeting (June 20). Meanwhile, many are hoping that next week French President Macron picks a new prime minister. The trick, of course, is that he/she needs to survive a vote of confidence from a national assembly that is very divided. France's 10-year bond yield was hovering near 3% before the European Parliament elections, and after first round of the snap-election called by Macron, the yield rose to about 3.37%. It has subsequently pulled back by 20 bp.

The euro was bid above $1.0850 in the European morning, before stalling with overextended intraday momentum indicators. Our concern is two-fold. First, it is hard to imagine the market can price in more than two Fed rate cuts this year given that there are three meetings left this year after this month, and second, that the US two-year premium over Germany has narrowed to 170 bp and that could prove to be the near-term floor. Sterling shines, helped by the firmer GDP reading. After closing firmly yesterday, it has risen to $1.2880 today, its best level since March 8 when the year's high was set near $1.2895. Some of sterling's gains against the greenback may have been helped by cross rate demand. Sterling rose to its best level against the euro in nearly a month. It is the strongest G10 currency here in July, up about 1.85% against the dollar. Still, the daily momentum indicators are getting stretched and $1.30 seems too far. 

America

The bar to a Fed cut in September seems low, though as we noted, there are two more jobs and CPI reports (after today's) before then. In testimony this week, Fed Chair Powell indicated that while the recent data has been encouraging, more is needed to spur a cut. And more is coming. A 0.1% in the headline CPI today would see the annualized pace in Q2 fall to 1.6% after a 4.4% annualized pace in Q1 23 and a 2.0% pace in Q4 23. Similarly, a 0.2% rise in the core rate would translate into a 2.8% annualized rate in Q2 24 down from 4.8% in Q1 and a 3.2% annualized pace in Q4 23. At the same time, the labor market is cooling from albeit strong levels. The jobless claims have risen steadily in recent weeks, and the four-week moving average has risen from about 214k at the end of Q1 to 238k at the end of Q2. That is the highest since last August. Powell explained that the risks are more balanced now. The most negative combination for the dollar today is a soft CPI and higher weekly jobless claims.

Despite the weakness in last week's Canadian employment report and (slightly) increased wagers of Bank of Canada rate hike this month (~66% vs. ~50% a week ago), the Canadian dollar remains firm. The greenback is pinned in the lower end of its CAD1.36-CAD1.38 trading range that has prevailed for the better part of three months. A break of the near-term CAD1.3600-CAD1.3650 range may signal the direction of the next move. There are $540 mln in options at CAD1.3650 that expire today. At its low yesterday, the dollar slipped below MXN17.77. It is the lowest in a little more than a month. It was the six declines in the past seven sessions. The greenback is consolidating today above MXN17.81. The main worry for many investors is what happens in September when AMLO new Congress with an overwhelming majority and before Sheinbaum is inaugurated. But that is a month and a halfway and the carry is prohibitive for peso shorts without downside momentum. Speculative gross long peso positions in the futures market have been grown by almost 25k contracts in the past two weeks (through July 2). That rebuild about a third of the gross longs that were cut the middle two weeks of June.